A light at the end of the inflation tunnel?

The latest CPI data showed that quarterly inflation was 1.2 percent in the March 2023 quarter, and prices went up by 6.7 percent compared to the same quarter last year. While these results would be reason for concern a few years ago, they were met with optimism since the annual inflation rate is now the lowest since March 2022.

There are a range of factors bringing inflation down, one of them being the labour market starting to cool down. The analytical unadjusted Labour Cost Index is a proxy for wage inflation. It tells us how the cost of labour has changed over a set period, while accounting for changes in the quality of employment, such as employees receiving promotions or moving to different roles. From January 2021 onwards, the analytical unadjusted LCI grew strongly, reaching an annual growth of 5.7 percent in the December 2022 quarter.

Wage inflation is driven by demand for labour being unmatched by supply, meaning that when unemployment is very low (tight labour market) we can expect wage inflation to rise, with the contrary also true. Moreover, there are some early signs that the upcoming labour market statistics will show wage inflation growth slowing. For example, in the year ended February 2023 net migration reached pre-COVID-19 levels (52,000). This is expected to increase the supply of labour in New Zealand, as many migrants are seeking work.

The SEEK applications per job adverts index (SEEK index) could be used as an indicator on where unemployment is heading if we assume that a larger number of applications per job advert means there are more unemployed people looking for work. Historically the unemployment rate follows the trend set by the SEEK index, although it is much smoother. The SEEK index has been growing since June 2022. While the unemployment rate started to grow very slowly beginning in the same quarter, and its growth is expected to pick up pace in the March 2023 quarter, as it is likely to continue to follow the trend set by the SEEK index.

The unemployment rate does not follow the SEEK index more closely because, unlike the SEEK index, it considers New Zealand’s entire work force. Also, not everyone applying for a job is counted as unemployed in the official statistics, as many may be moving between roles.

Apart from the labour market showing signs of a cool-down, oil prices have fallen significantly over the past months, contributing to lower inflation. The price of Brent crude oil peaked at US$123 per barrel in March 2022, resulting from sanctions imposed in response to Russia’s invasion of Ukraine. Since then, oil prices have been declining as other nations have ramped-up production. The price of Brent crude oil has fallen to US$81 per barrel, which is similar to prices before the invasion.

Since October 2021, the Reserve Bank of New Zealand (RBNZ) has been increasing the Official Cash Rate (OCR). It went from 0.25 percent in August 2021 to 5.25 percent in April 2023. These consistent OCR hikes have increased the price of credit, as lenders use the OCR as a base to set commercial interest rates. This in turn has a slow-down effect on businesses and households’ demand for goods and services, as it gets more expensive to take out a loan to make capital investments or purchase a big-ticket item. OCR hikes also encourages households to save more as they receive higher interest rates on their deposits and investments, reducing the amount of money circulating in the economy.

In summary, we can be cautiously hopeful that the worst of inflation has passed. It is very likely that the labour market is cooling down, and higher net migration will ease bottlenecks in the labour market. It is also likely that higher OCR is playing its role as intended in taming inflation. Lastly, oil prices falling has also positively impacted the latest CPI result, however, the surprise OPEC+ announcement of oil output cuts could hinder the trend of slowing inflation growth.