Concerns rise that higher inflation won't be temporary

Thursday, 13 May 2021

Reserve Bank former chief economist, John McDermott, explains how inflation is measured and how it manifests itself.

A surprising sharp rise in inflation in the United States has increased nervousness that global inflation could take hold and knock New Zealand’s loose monetary policy off track.

Jarden senior economist John Carran said most economists believed a 4.2 per cent year-on-year jump in the US consumer price index that was reported on Wednesday night, New Zealand time, was temporary.

But it could take “towards the end of the year” for the factors driving inflation to subside, he said.

And if that was the case, it was possible higher inflation could start to impact wage expectations and take hold, he said.

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* More doubt over interest rate cuts after inflation surpises at 1.4%

“If everyone looks at this as temporary then this will pass through,” Carran said.

“But the danger, particularly given the level of government and central bank stimulus, particularly in the US with hand-outs to households and very loose monetary conditions, is that people start to build it into their expectations.”

The Economist reported that the inflation jump was a big acceleration from the previous month's figure of 2.6 per cent and “considerably more than many analysts had expected”.

Soaring lumber prices are one of the factors driving up inflation.

Carran said the same factors that had driven US inflation higher were likely to impact New Zealand’s June quarter consumer price index.

“We have seen the same impact from commodity price rises and we are also coming off a low base last year, so we are going to see a spike in inflation too.”

That could prove a challenge for the Reserve Bank, he said.

“They have clearly said they want to ‘look through’ a short-term rise in inflation and it is going to be hard to toe that line if we get a couple of quarters of ‘much higher than target’ inflation.

“You would get a bit of tussle between them and the market, I think, in terms of who is right.”

One of the reasons inflation was rising in the US was that businesses cut back their production too far last year in anticipation of lower demand due to Covid, and that was showing through in shortages now, he said.

“What happened during the pandemic is a lot of factories shut down or severely reduced their output but demand didn’t really fall off.”

A global shortage of computer chips has been causing production problems for a wide variety of industries, including car manufacturers, for example.

The Economist said the US inflation number was considerably higher than analysts expected.

“That is all feeding through into consumer prices.

“It is just a question of how long it takes supply chains to adjust to such a significant shock.”

Carran agreed declining business investment, post-pandemic fatigue in the workforce, and lower levels of geographical labour mobility could all slow a production bounce.

“To a degree I think that will be the case. There will be a little bit of scarring from the pandemic.

“But at the moment, manufacturing production is running pretty hot around the world.”

Carran noted a wide variety of commodities from oil to metals had also increased in price.

The price of lumber has almost doubled in the US since the start of the year.

Sharemarkets slipped and bond yields around the world jumped in response to the inflation figure on Thursday.

The US S&P 500 index slid 2.1 per cent to close at 4063, while the NZX 50 index closed down 1.1 per cent.

The yield on US 10-year Treasury bonds climbed by 10 basis points to 1.69 per cent over the week, while the yield on New Zealand 10-year government bonds rose by 15 basis points to 1.90 per cent over the same timeframe.

However, bond yields still remained a little below the peak they achieved in March when inflation concerns were also bubbling.

Carran said that if 10-year rates rose above 2.5 per cent “markets and central banks will get a little bit worried”.

ANZ chief economist Sharon Zollner warned in March that if mortgage rates were pushed up by 1 per cent, that would lead to Aucklanders’ disposable income being slashed by 5 per cent.