Auckland city business and economy report 2008

Inflation, interest rates and the exchange rate

New Zealand's inflation has risen to 3.4 per cent in the year to March 2008 and is expected to exceed 4 per cent this calendar year. High food and fuel prices have been key contributors to this.

New Zealand's official interest rate was the highest in the Asia-Pacific region in May 2008 at 8.25 per cent.

The New Zealand dollar was strong against the US dollar in May 2008 due to weakness in the US housing market and the global credit crunch.

New Zealand's inflation rose by 0.7 per cent in the March quarter of 2008, bringing inflation to 3.4 per cent in the year to March. This is above that of 2.5 per cent in March 2007 and is the highest since June 2006. This matched the Reserve Bank's expectations, but was outside its target inflation rate of 1-3 per cent.

Inflation can be analysed as tradable and non-tradable inflation. Non-tradable covers price rises in goods and services that cannot be exchanged with other countries (for example, dining out), while the tradable component includes goods that are, or could be, traded.

Non-tradable inflation increased by 1.1 per cent over the March 2008 quarter, contributing to an annual percentage change of 3.5 per cent. Tradable inflation increased by only 0.2 per cent during the March quarter, but rose to an annual increase of 3.4 per cent, up from an annual decrease of -0.5 per cent in the June 2007 quarter. Events in the global economy had a large (direct and indirect) impact on both of these categories.

Higher food (particularly grocery food), fuel prices and housing costs have been the key contributors to rising inflation. Furthermore, their relative contribution to inflation has also increased.

Landlords are pushing up rents, shifting their focus away from capital gain to return on investment at a time when there is greater demand for rental properties due to high home ownership costs. New housing costs and household insurance have also contributed to inflation. As essential areas of expenditure, this has increased the pressure on households.

Yet, on the positive side, recreational goods (such as package holidays, audio-visual and computing equipment, and newspapers, books and stationery) became cheaper during the March quarter.

Food and energy price rises have been offset to a degree by cheaper imports through a stronger New Zealand dollar and retail discounting associated with the slowdown in the retail sector. However, despite these offsets, retail prices rose strongly during the March quarter, up 1.9 per cent on the December quarter.

Inflation is forecast to reach or exceed 4 per cent this calendar year, leaving little room for the Reserve Bank to make any large reductions to the official cash rate. This means that home owners and households are unlikely to experience much relief from high mortgage rates or essential expenditure items in the near term.

Some forecasts have not anticipated inflation coming back to within the Reserve Bank's target band until the latter half of 2010. Much of this is currently beyond what can be controlled domestically, due to the large impact of international events on our economy. This includes global commodity price rises and generalised world inflation.

Inflation

Annual percentage

Source: Reserve Bank of New Zealand.

New Zealand's official interest rate is relatively high in comparison to other developed economies and in May 2008 was the highest in the Asia-Pacific region at 8.25 per cent. Australia's interest rate was 7.25 per cent. High interest rates attract foreign capital, increasing the value of the dollar and placing strain on exporters. In line with other economies, the Reserve Bank uses the official cash rate, which in May 2008 had been at 8.25 per cent since July 2007, to control inflation.

The New Zealand dollar has increased in value against the US dollar due to weakness in the US housing market and the global credit crunch. Over May 2008 it was valued at an average of 0.7769 cents, 33 per cent above its 10-year average.

In the last year the New Zealand dollar has also increased by 11.8 per cent against the UK pound, bringing it to 18 per cent above its 10-year average. It has decreased against other major currencies, the Australian dollar (-1.7 per cent), the Japanese yen (-1.0 per cent) and the Euro (-1.8 per cent) over the last year, although it is 21 per cent above its ten-year average against the yen. The New Zealand dollar is not expected to depreciate significantly until there are signs that the Reserve Bank will loosen monetary policy and the US dollar regains strength after the housing market slump.

Interest and exchange rates

Source: Reserve Bank of New Zealand.

Published August 2008