Higher inflation in NZ will be 'new normal'

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Global inflation has peaked, but it is expected to take more time before domestic inflation falls to within the Reserve Bank’s (RBNZ) 1 to 3 percent target range.

Salt Funds Management economist Bevan Graham said people should be wary of calls for

early and aggressive interest rate cuts, given current economic conditions and inflation.

“I think we are in a ‘new normal’, or even ‘old normal’ environment, in which inflation is going to be a bit tougher to keep under control.

“I think we’re going to see a period in which central banks [will need] to be a lot more active than … over the last 15 years, to keep inflation in check,” Graham said.

While most central banks around the world indicated that interest rate hikes had peaked, the Reserve Bank was yet to rule them out, as population growth continued to drive non-tradeable inflation, such as rents.

While Salt’s latest global report was focused on the United States and European markets, Graham said the major Asian markets of Japan and China were also ones to watch.

Graham said Japan looked as though it might escape a prolonged period of low economic growth and deflation.

However, China’s future was more uncertain.

“Much of what ails the Chinese economy is structural in nature including debt issues, demographic challenges, and geopolitical tensions. These all point to weaker growth prospects in the period ahead. That suggests more policy easing is likely – the risk being it remains reactive and too timid.”

Turning to New Zealand, Graham said the Reserve Bank was the first to hike interest rates, and may be the last to cut them, given a long list of negatives for the economy.

“We believe the first half of 2024 will be the toughest period yet for the economy. Ongoing pass-through of higher interest rates, slowing employment growth, weaker business investment, and softer global growth all paint a picture of broad-based weakness in activity in the period ahead.

“The bottom line is we believe the RBNZ has done enough tightening, but we don’t expect the first cut in interest rates to come until November this year.”

Graham said the outlook for New Zealand equities would continue to reflect the ongoing economic conditions and high interest rate environment.

“Overall, our base-case scenario is unchanged, with a trough in earnings for New Zealand cyclicals expected around mid-CY24 (calendar year 2024), followed by a gradual resumption of earnings growth.”

In the meantime, he said investors were likely to continue to favour global equities over New Zealand assets.

“The upshot for markets of the current inflection point between a period of restrictive monetary policy and a neutral period, is that benign returns can still be expected, unless a sentiment swing on the interest rate outlook or on consumers’ optimism and willingness to spend disrupts the central scenario.”