It’s been a long time coming, but inflation is now back below 3% - more than three years to be exact. At 2.2%, the midpoint of the RBNZ’s 1-3% target band is well within reach. And the cost-of-living crisis is coming to an end (see the COTW).

Over the September quarter, fewer items in the CPI basket recorded an increase in price (from 56% to 53%) while more items either recorded no change in price (from 12% to 14%) or declined in price (from 32.7% to 33.4%). And compared to a year ago, a far larger proportion of the basket recorded price declines – from 29% to 33.%. The shift points to generalised cooling in inflation pressures.

Even better news is the continued correction in core inflation. Stripping out volatile food and energy prices, underlying price pressures lifted 1%. Annually, core inflation is now just skimming the top-end of the RBNZ’s 1-3% target band at 3.1%. It’s a very welcome move confirming the underlying trend for inflation is down. And even better – moving closer to being below 3% in the coming months.

The September update was a great report, but it wasn’t perfect. The blemishes in the report were the few items still recording chunky price increases. Council rates increased 12.2% in the quarter, accounting for over half of the overall 0.6% increase in consumer prices. Rents let off a bit of steam but still running at 4.5% - well above the pre-covid ~3% rates. Pharmaceutical products had a particularly expensive quarter, up 17%, following the reintroduction of the $5 prescription payment

Imported prices are falling, and are down -1.6% over the year. Tradables – imported inflation – has done most of the work in wrangling inflation back within the band. The eventual normalisation in domestic price pressures is why we see inflation sustained at 2% in the medium-term. Domestic inflation is a slow-moving beast. The good news is that it is now moving in the right direction. Non-tradables price growth has slowed from 5.4% to 4.9% on an annual basis, and is some distance from the 6.8% peak. It’s the first time since September 2021, domestic inflation is sitting below 5%. That said, domestic inflation is still sitting high above the long-term average (~3%).

There is lingering strength in homegrown inflation, but underlying domestic price pressures are clearly weakening. And we still have more deflationary pressure in the pipeline as the economy runs below its productive capacity.

The risk in the near-term is inflation undershooting 2%. The RBNZ has begun relaxing interest rate settings. But a cash rate of 4.75% is still restrictive. If domestic inflation normalises faster than expected, then we will likely see inflation falling into the lower-end of the RBNZ’s target band. And that opens the door to further large reductions in the cash rate.

The light at the end of the tunnel is burning brighter. Cost pressures are easing. Great news for businesses and households, and interest rate relief is coming thick and fast. Policy settings are still restrictive, but more interest rate cuts are coming. We expect another 50bp cut in Nov. Falling inflation, and falling interest rates will help household budgets, and business opex.

Financial Markets

The comments below were provided by Kiwibank traders. Trader comments may not reflect the view of the research team.

In rates, the bull steepening theme continued.

“Kiwi rates had a bumpy start to the week as limited liquidity saw rates move up and down without a clear driver. They remained skittish in the lead up to CPI until Wednesday’s soft print gave the market direction that was missing. The weight of flow in the short end remained heavily received seeing short end drift back toward recent lows, though enthusiasm for a 75bp cut in November waned over the day.

The bull steepening trend of recent weeks continued unabated, with 2y swap rate down nearly 10bps on the week while the 10-year yield near on unchanged. The market is now pricing a deep series of cuts and one offshore commentator is now calling for three consecutive 50bps cuts. Though the shape of the curve is now implying higher a shorter cutting cycle and a higher terminal rate. So now we have 100bps of cuts priced into February, but the implied terminal rate has bounced 20bps off its low.

The always unpredictable Aussie employment data surprised the market with a very strong print and scotched tentative expectations of cuts this calendar year. This flowed through to NZ and alongside NZGB tender on Thursday stalled the downward momentum in Kiwi rates and saw the curve steepen further.

The panel for the 2030 NZGB tap was announced last week and is widely expected to launch this week given clear air. This is likely to be well supported by balance sheets given 5y tenor and see a pay side swap flow dominate for a change. With no major data until early November the US election is likely to steal the focus.” Matthew Crowder, Balance Sheet Manager – Treasury.

In currencies, NZ CPI pretty much now at target.

“Over the last couple of weeks, the Kiwi dollar has been provided with a little more certainty as far as likely direction from here, and it bolsters our argument for a lower Kiwi. The RBNZ have kicked into gear, now having delivered 75bp of cuts to the OCR, and more is expected, with the majority of economists expecting another 50bp cut in November. And given the time between meetings, from November to February, they are better to deliver a full 50bp. Another key piece of the puzzle was delivered last week, as we saw NZ CPI data almost back at the RBNZ’s target rate of 2.0%. Headline CPI was +0.6% for the September quarter, and +2.2% y/y. We are very nearly there. And while there are some risks that we may get a resurgence in inflation, it is looking good, particularly the domestically driven inflation which is starting to turn a corner. Last week the Kiwi dollar was fairly range bound against both the US and Aussie dollars, as market expectations had already priced in the lower CPI print, and on the day the print looked pretty much bang on expectation, with some additional good news thrown in . The Kiwi dollar opened the week at 0.6100 and got to a low of 0.6045 following the CPI Print. It then found some support and traded back to a high of 0.6080. We closed the week at 0.6072. With not a lot on the data front this week, it may be another tight range ahead of us. Similarly, the NZDAUD cross opened at 0.9030 and traded up to a high of 0.9090. Some much stronger than expected employment data out of Aussie saw us touch a low of 0.9037, and we ended week back at 0.9050. From here, it’s a quiet week, but we will hear from several central bank officials across the week. We see the Kiwi likely range bound in the 0.6010-0.6090 territory against the Greenback. And NZDAUD we see slowly trading lower into the 0.9010 – 0.9070 range, as the rate differentials continue to drag the cross a little lower.” Mieneke Perniskie, Trader - Financial Markets.

Weekly Calendar

• The economic calendar is light this week - both here and abroad. Instead, central bankers are in focus with the IMF and World Bank annual meeting taking place this week in Washington, DC. Speeches and appearances are scheduled from the Bank of England Governor Andrew Bailey to a host of ECB officials including President Christine Lagarde. RBNZ Governor Adrian Orr is also due to speak in Washington on Thursday morning (NZ time) on monetary policy. RBNZ Assistant Governor Karen Silk is also scheduled to speak on Tuesday at a CBA conference on domestic financial markets.

See our Weekly Calendar for more data releases and economic events this week.