New Zealand Core and Headline Inflation Stop Falling; Headline Near 2%; Core Near 3%

New Zealand’s CPI shows an acceleration in the fourth quarter of 2024 compared to the third quarter. The year-over-year increase is at a relatively modest 2.2%; however, the New Zealand core that excludes food and household energy as well as vehicle fuels is running at 3.1% over four quarters. The inflation progression for the core takes inflation down to 2.5% over two quarters then back up to a 2.9% annual rate over one quarter. The graph shows that the decline in the year-over-year core and headline inflation rates have stopped in this most recent quarter; that raises the question about where inflation goes next.

There is nothing final about the pause that we see in the drop in inflation. It might be a pause that then continues its downward move, or it might not. However, as you can see from the chart, taking away the big inflation hump that we had during COVID and extrapolating a trend line from before COVID inflation puts inflation on an accelerating path. In fact, inflation, whether measured by the headline or the core, shows both above those previous trends even if we set aside the bulge of inflation during COVID.

However, inflation news is resplendent for its ability to give us mixed signals! The more that we look at it, the more it stares back in confusion. If we look at the CPI categories, we see inflation acceleration is not common: over four quarters it's occurring in only 8% of the categories; over two-quarters it's occurring in 25% of the categories; over one quarter it's occurring in only 42% of the categories. Comparing inflation month-to-month, the accelerations are below 50% for the fourth quarter, the third quarter, and the second quarter. Second-quarter inflation breadth was especially narrow even though the headline increase was slightly more in Q2 than it was in Q3. Such is inflation.

What this demonstrates is that inflation is not well behaved in ways that might make sense to us. And in that it's somewhat similar to what I would refer to as football ratings! Ratings in the U.S. and probably soccer ratings as well in Europe and elsewhere frequently show that normal ordering statistics don't always hold. If A is greater than B and B is greater than C, then A ‘should be’ greater than C as well. But in sports you cannot order teams in this way because if team A beats team B and team B beats team C, team C just might turn around and beat team A. That fouls up the entire ordering system. Inflation similarly defis attempts to create separate independent evaluations of it and its progress that are on the page. Inflation is not alone in creating a complicated environment for a variable we would like to order and understand better. Economists continue to debate inflation and its causes. COVID is still hotly debated about whether it was because of supply-shocks, fiscal spending, or too much money supply growth. Depending on the ideology of the economist that you talk to, you're going to get a different answer about what was principally responsible.

In New Zealand, wages continue to run at a stronger pace than prices although their speed is slowing, and the unemployment rate continues to rise; we would expect the rising unemployment rate to reduce the growth rate of wages and to help contain inflation. But so far, that is not yet being done successfully. New Zealand’s 10-year government bond yield has fallen below its three-month treasury bill yield; the inverted yield curve is a signal of rates being relatively high and often a signal of a coming economic slowdown or possibly even a recession although in recent times the inverted yield curve has failed to be a significant forecaster of recession, at least in the U.S. and at least so far. Money supply growth has been modest in New Zealand well; gross domestic product has begun to slip below zero in the most recent two quarters.

On balance, New Zealand's inflation trends are disappointing. The failure of inflation to keep falling is most disappointing; however rising unemployment, and slowing GDP growth, provide some basis to think that the drop in inflation is likely to reassert itself, especially in an environment where money supply growth remains contained and where credit growth has been relatively flat at a modest pace. In addition, inflation has fallen sharply enough and is low enough to have created a high real interest rate when past inflation is compared with the current 10-year bond yield. That is a maturity mis-match for sure, but it is also a reasonable and venerated measure of the tightness of monetary policy if it is used correctly. Balancing all these complexities, it would seem that the Reserve Bank of New Zealand (RBNZ) is still in a pretty good place with respect to where inflation is despite the fact that inflation is over target, and it has stopped falling. However, the clash between the central bank and inflation is more properly characterized as a battle than a war. It's not a war because it's not won or lost. It’s a battle because it's constantly fought. The RBNZ I'm sure will remain vigilant even though it would appear to be in a relatively strong position to deal with the circumstances in hand. The battle continues but the RBNZ seems to occupy the high ground for now.