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The sky high New Zealand dollar is painting a flattering picture of inflation.
Two things limit how much comfort the Reserve Bank, and therefore borrowers, can draw from yesterday's pretty benign consumers price index.
It knows that prices of non-tradable goods and services, which are not influenced by international competition or the exchange rate and make up about 56 per cent of the CPI, are the main drivers of core or persistent inflation.
Non-tradables inflation, which reflects what is happening in the inward-facing sectors of the economy where monetary policy generally has more traction, has been rising pretty relentlessly.
Though it softened a bit in the latest quarter, the annual rate has averaged 2.9 per cent over the past four quarters, up from 2.4 per cent over the previous four.
The other ground for discomfort at the central bank is that it regards the kiwi dollar as unsustainably high, which limits the extent to which it can expect a rising exchange rate to keep a lid on prices of imported and exportable goods, and the rate of tradables inflation accordingly low.
Tradables inflation was 0.1 per cent in the year to June 2014, the first time the annual rate has been positive since March 2012.
The Bank for International Settlements calculates effective (trade-weighted) exchange rates on both a nominal basis and after adjusting for relative inflation rates. On both nominal and real measures the New Zealand dollar has appreciated more since 2010 than any other currency among the 27 it monitors.
The Reserve Bank in the forecasts it released last month assumes that the kiwi dollar will fall gradually over the next three years, by about 7 per cent on a trade-weighted basis. No sign of that so far, though; in fact it has risen nearly 3 per cent since then.
If there is a kind of arm wrestle going on between the two big influences on the exchange rate - interest rate differentials and commodity prices - the former seems to have the brawnier biceps.
ANZ's index of export commodity prices fell for the fourth month in a row in June, to 6.7 per cent below the peak recorded in February. And that is before the latest drop in dairy auction prices, to more than a third below their February peak.
Combined with higher world oil prices that foreshadows a decline in New Zealand's terms of trade, albeit from the most favourable level in more than 40 years.
So far, though, the foreign exchange dealing rooms don't seem to have got the memo, or at least are more focused on the widening gap between New Zealand interest rates and those prevailing in more sluggish economies.
We may have already seen the top of this cycle in terms of quarterly growth rates but it adds up to a rate higher than the 2.8 per cent the Reserve Bank reckons the economy can sustain without bottlenecks emerging and inflation becoming problematic.
There were some signs of emerging capacity constraints in last week's quarterly survey of business opinion (QSBO) by the New Zealand Institute of Economic Research.
Its measure of capacity utilisation rebounded to a level well above the long-run average for this indicator. It reflects the responses of manufacturers and builders when asked how much is it practicable for them to raise production from existing plant and equipment without raising unit costs.
Another indicator is how many firms in all sectors cite a lack of capacity as the single factor most limiting their ability to increase turnover. It has been rising steadily and is now approaching the levels prevailing during the mid-2000s boom.
The net balance of firms reporting that they have raised their prices has been rising steadily to levels the institute says point to an inflation rate around 2.5 per cent by the end of the year.
"Price increases are expected to stabilise around these levels," it said.
"The price increases are consistent with margin expansion as costs have remained subdued." That is certainly true of wage costs.
Always a cyclical laggard, the labour market right now is marked by strong employment growth being matched by strong growth in the supply of workers as fewer people leave for Australia and more return.
The unemployment rate has been stuck at 6 per cent or thereabouts since the middle of last year, well above any plausible estimate of the rate at which it would put upward pressure on inflation.
Statistics New Zealand's quarterly employment survey recorded wage growth of 2.5 per cent over the year to March (average hourly earnings across private and public sectors including overtime).
That is 1 percentage point more than the inflation rate for the same period, and it is up from 2.1 per cent a year earlier, but down from 3.9 per cent a year before that. The average rise in ordinary time wages and salaries in the private sector alone was 2.9 per cent in the latest March year, up from 2.3 per cent a year ago but down from 3.8 per cent a year before that.
But again the QSBO detects some signs of incipient pressure.
The proportion of firms reporting that it is getting harder to find the labour they need - both skilled and unskilled - is rising.
And reported hiring is on a rising track, consistent with annual employment growth of more than 3 per cent, the institute says.
So as governor Graeme Wheeler surveys the world from high above The Terrace, what does he see?
A currency which has proven exceptionally strong over the past few years and which is defying gravity, relative to falling export commodity prices.
For how much longer can he rely on that to offset rising inflation in the domestic economy?
He sees an economy growing at a pace well above its potential, or sustainable non-inflationary rate.
And he knows that changes he makes to the official cash rate will take between one and two years to have their full effects on output and then inflation.
About the only comfort he can take from yesterday's June quarter inflation outcome is that it leaves the annual rate at 1.6 per cent, far enough below the mid point of his target band to give him some latitude for a pause, after next week's OCR hike, to assess the effects of what he has done so far and the implications of tumbling dairy prices.
- By the NZ Herald