We expect the RBNZ to raise the OCR by 25bp next week, taking it to2.75%. Data since the last meeting has been mixed, and while it supports our view that the bank's hiking cycle will be shallower than markets currently price, it is not a case for complacency on the potential inflation risk in NZ.
On inflation, Q2 CPI printed hotter than the RBNZ had expected, with the headline inflation rising to 4.1% YoY, above both our forecast and the bank's own 3.9% projection (which was revised down from 4.2%). The upside surprise was concentrated in fuel, with the Iran conflict driving asharp rise in transport costs, while housing and household utilities alsofirmed. Having said that, measures of underlying inflation proved generally contained. Non-tradable inflation eased to a six-year low on a quarterly annualised basis, and core measures excluding fuel and food slowed further, suggesting the bank should take some comfort thatunderlying pressures remain broadly in check even as headline inflation rose sharply.
PPI data for Q2 also pointed to similar themes, with input costs, led by transport costs (largely due to sharp rises in fuel), rising faster thanoutput prices. The pass through to output was present but not severe,though it remains a risk the RBNZ will need to watch given elevated cost pressures reported in business surveys.
Having said this, more recent inflation indicators have softened a touchmore than expected. July's SPI data came in a bit soft, particularly insome of the stickier components such as rents, and supported the RBNZ's decision to lower its Q3 inflation forecast to 3.3% YoY in its July statement. The RBNZ's own inflation expectations survey for Q3 told asimilar story, with the one and two year ahead measures falling sharply and now sitting at or below levels last seen before the conflict escalated. Together, this supports our reading that the Q2 overshoot will prove temporary rather than a sign of inflation becoming embedded.
Turning to the labour market, conditions have softened by more than the RBNZ expected, with unemployment rising to 5.6% in Q2 against a forecast of 5.4%. The tick up in the unemployment rate owed more to stronger labour supply and a firmer participation rate than to weaker demand, with employment growth actually beating the bank's expectations. The RBNZ operates under a single mandate, so this will not be a decisive input, but it reinforces our view that the bank will want to proceed cautiously from here.
On household spending, consumption has shown some resilience of late,but the trend still remains relatively soft. Retail volumes fell in Q2,concentrated in fuel and other categories directly hit by the conflict,while core volumes rose. Higher-frequency measures show spending held up in July, though it remains weak against pre-conflict levels. We expect only modest growth through the second half of the year as higher rates, increased cost of living, and a softening labour market weigh on households.
