The chief economist of the Reserve Bank of New Zealand has indicated that the pace of inflation decline in the country may not align with the central bank's earlier forecasts, suggesting the possibility of additional interest rate increases down the line.
In a speech delivered in Wellington, Paul Conway highlighted that recent geopolitical developments in the Middle East have introduced an upside risk to the bank's inflation forecast for the third quarter. The central bank had recently revised its Q3 inflation expectation down to 3.3% from 4.3%, a move largely attributed to falling fuel prices following a provisional agreement between the US and Iran. However, the recent resurgence of conflict in the region has pushed oil prices higher once again.
Conway stated that the central bank would respond if inflationary pressures stemming from the Middle East conflict prove more enduring than anticipated.
Last week, the Reserve Bank of New Zealand raised its Official Cash Rate by 25 basis points to 2.5%, marking its first rate hike in three years. The bank described this action as a step towards gradually withdrawing economic stimulus and ensuring inflation returns near the midpoint of its 1-3% target band next year.
Policymakers are concerned about the potential for medium-term inflation to become entrenched, prompting a desire to adjust the OCR gradually towards a neutral level. They also project an economic recovery in the latter half of 2026, which could introduce further price pressures.
Hawkish signals from the central bank, coupled with a series of positive economic indicators, have led traders to price in two more rate hikes this year, boosting the New Zealand dollar. Investors currently expect the OCR to reach 3% by December, with market pricing suggesting another potential increase in the first quarter of 2027.
Conway noted that short-term inflation pressures appear to have eased for now, which is a welcome development. However, he cautioned that the conflict in the Middle East represents another significant inflationary shock for both the global and New Zealand economies.
The Reserve Bank believes sufficient economic slack remains, which should make it more difficult for businesses to fully pass on cost increases to consumers. Conway added that this spare capacity is expected to temper corporate pricing decisions over time, aligning them more closely with a low and stable inflation environment. Concurrently, a less stimulative monetary policy stance should help reduce medium-term inflation pressures.
Nevertheless, a survey released by the New Zealand Institute of Economic Research on Tuesday suggests businesses still intend to keep raising prices. The Quarterly Survey of Business Opinion found that 54% of firms reported higher costs in the three months to June, and the same proportion expect costs to rise further in the current quarter.
The survey, which covered over 800 businesses, also revealed that 41% increased their prices in the second quarter, while 54% anticipate doing so in the current quarter.
Christina Leung, Deputy Chief Executive at NZIER, commented that rising cost and pricing indicators point to strengthening inflationary pressures within the New Zealand economy.
Conway concluded that while oil prices have retreated from recent highs, the effects of the oil price shock will continue to ripple through the economy for some time. He emphasized that inflation becomes more persistent when businesses find it easier to pass on cost increases, and the longer inflation remains elevated, the more forceful monetary policy must be to return it to target.
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