Spike in NZ inflation seen unlikely to send economy into tailspin

WELLINGTON - Alarm bells rang in New Zealand this week when inflation hit a 16-year high due mostly to the impact of higher oil prices but economists see little prospect of a return of the 1970s oil shock turmoil.

By (AFP)

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Published: Sun 23 Jul 2006, 7:20 PM

Last updated: Sat 4 Apr 2015, 3:15 PM

New Zealand is caught between the twin perils of a sharply slowing economy and rising inflation but Westpac bank economist Nick Tuffley says that there is no reason to expect a return to the bad old days of stagflation.

“We’ve moved on a long way from the sort of cost plus mentality we had before the 1980s (economic) reforms,” Tuffley said.

“Businesses are not rushing to pass on costs -- they are wearing it on the chin at the moment.”

The oil shocks of the 1970s led to massive increases in the price of oil. By 1980 the price of a barrel of oil was around 38 dollars -- or 90 dollars in today’s inflation-adjusted terms.

The legacy was years of stagnant economic growth coupled with high inflation in the teens, which was known as stagflation.

In the last three years the price of a barrel of oil has jumped from around 25 dollars a barrel to a record 78.40 dollars earlier this month.

Figures released Tuesday showed that New Zealand inflation hit 4.0 percent in the year to June, the highest for five years. Prices in the June quarter were 1.5 percent higher than the previous quarter, the biggest jump for 16 years.

This is nothing like the double-digit inflation common in the 1970s and 1980s but well above the average of around 2.5 percent of recent years.

Statistics New Zealand said if higher petrol prices were stripped out, the annual inflation rate would have been 2.9 percent, just below the central bank’s mandated target of one to three percent in the medium term.

The biggest risk from increasing inflation is that it will start flowing into other areas of the economy. Most importantly, the central bank fears that workers will demand bigger pay rises and companies will pass on increased costs by raising prices.

“You start getting back into that vicious cycle where inflation expectations start going up,” Tuffley said.

“If that happens it becomes very hard to drag inflation back down into the (central bank’s one to three percent) band.”

Westpac sees little sign of this happening and doubts the central bank will see enough of a looming inflation threat to raise rates again.

“At the end of the day we are still in an economy which is going to be slowing, it’s going to be growing well below its potential growth rate,” Tuffley said.

The government expects the economy to grow only 1.1 percent in the current year to March, compared with average annual growth of 3.5 percent in the previous five years.

Other underlying inflation pressures should gradually abate despite a short term spike caused by fuel prices, higher food prices following recent bad weather and a decline in the exchange rate.

In recent months central bank governor Alan Bollard has been saying the series of rate rises in 2004 and 2005 is over.

But until the latest inflation data there had been expectations by some in financial markets that rates could be cut this year in response to the slowing economy. But these hopes have been dashed and no one sees the likelihood of a cut until well into next year.

BNZ Bank chief economist Tony Alexander says inflation is unlikely to fall below three percent until 2008 and the official interest rate will therefore also remain high at the current 7.25 percent.

“There are simply too many factors around to reasonably expect that inflation will comfortably ease off over the next couple of years,” Alexandersaid in a report.

He cited rising local government rates, rising world inflation, depreciation of the New Zealand dollar and tightening corporate margins as reasons to expect inflation will remain above three percent.

Alexander still believes the central bank is unlikely to raise rates again in the current cycle, despite the inflation threat.

“Instead we have become more certain that the easing of monetary policy remains a long way away,” he said.

The central bank is due to meet on Thursday to decide on interest rates and Alexander expects there will be no change except for some “harsh words” about the outlook for future rate cuts.

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