Since June last year, US inflation has been bouncing around 3%. And the stickiness has kept rate cuts from the US Fed at bay, for now. The June update however shows encouraging progress. Over the month, consumer prices declined 0.1% which marks the first monthly decline in more than four years. The move was largely off the back of a drop in gas and durable goods prices. It was also good to see some easing in shelter prices, which has been the biggest hurdle. All up, the monthly decline saw the annual headline rate ease to 3% from 3.3%. The report was made all the better with further slowing in core inflation as the annual rate eased to 3.3% from 3.4%. Traders quickly moved to price in about a 90% chance of September rate cuts, up from about 70%. And despite the Fed signalling in June just one rate cut this year, markets are now pricing in about even odds of another cut later in the year. Alongside a loosening labour market, inflation in the US should soon fall below 3%. Rates markets remain volatile in anticipation of the easing cycle.

On Wednesday, it’ll be our turn to see how inflation tracked over the June quarter. We expect consumer prices rose 0.5% over the quarter, a slight slowdown from the 0.6% lift at the beginning of the year (see our full preview). Annually, we see inflation decelerating to 3.4% from 4% - the lowest in three years. Our estimate is some distance from the RBNZ’s May forecasts. The RBNZ expects a 0.6% rise in the quarter, and the annual rate easing to 3.6%.

Weakening imported inflation continues to do most of the hard yards in bringing down the headline rate. Tradables, however, is largely out of the RBNZ’s control. More important to the RBNZ and monetary policy, is domestic inflation. Because it is the kind of inflation over which the RBNZ has influence – to some extent. Home construction costs have swiftly responded to high interest rates. Other relatively less interest-rate sensitive components of non-tradables however, are moving in the wrong direction. The rise in rental inflation is a particular frustration as it alone makes up 9% of the CPI. The surge in migration continues to drive rents, which are estimated to have jumped around 1.2% over the June quarter. Annually, rental inflation continues to climb higher at 4.8% - well above the circa 3% pre-covid rates. Insurance and council rates will also be ones to watch on Wednesday. Both have climbed in the face of higher interest rates. Debt-burdened councils have hiked rates by double-digits. While Cyclone Gabrielle triggered a rise in dwelling insurance costs to the highest since the spike following the 2016 Kaikōura earthquake.

A return to the RBNZ’s 2% target midpoint hinges on a moderation in domestic inflation. Progress has been slow, so far. However, growing spare capacity should see a more meaningful slowdown over the second half of the year. Over the June quarter, we expect a 0.7% rise in prices for non-tradable items which would take the annual rate down to 5.2% from 5.8%. It is still well above the long-term average (~3%), but an encouraging fall from the 6.8% peak. The RBNZ’s forecast is not too different, with a 5.3% pencilled in.

In our view, the underlying trend is more important than the headline rate. Core inflation – stripping out the volatile price movements – peaked at 6.7% in December 2022. But disinflation in prices for core goods and services has been slow. The March quarter print, in particular, was disappointing as the measure remained at 4.1%. It is still a long way back to target. But we expect to see better progress given clear weakness in the economy.

The path for inflation from here, is the path for policy. Wednesday’s update should be confirmation that inflation continues to move in the right direction. And forward-looking indicators point to further moderation in price growth. Inflation looks on track to pierce below 3% by the September quarter this year, and on its way to 2% in 2025. And the psychological shift of seeing an inflation rate with a 2%-handle should not be disparaged. We continue to expect rate cuts to commence come November. Our view strengthened after last week’s Monetary Policy Review. The RBNZ’s language softened, just a touch (see our Chart of the Week). And we along with all market traders, have grown in confidence that a rate cut could be delivered this year – not the end of next year, as the RBNZ forecast in May.

Financial markets

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

In rates, an RBNZ pivot gets the markets’ attention

“An RBNZ pivot when no one expected it gets the rates markets’ attention. Markets have moved to price in -10bp (-8bp prior) of cuts for August, -29bp into October (-16bp), and -62bp into November (-39bp). There is bias here for -50bp cuts, and Fridays woeful NZ PMI data continued to aid that bias. However, there is a lot priced now so any data that comes out on RBNZ forecast or better will generate a good sized sell-off in the very short end.

The key RBNZ statements a trifecta of dovishness: ”inflation is approaching target range” , “there are signs inflation persistence will ease”, completed by “restrictive monetary policy has significantly reduced consumer price inflation”. Enough to generate a -20bp rally in front end rates on the day, with momentum continuing over Thursday/Friday seeing 2 year rates down -35bp on the week. The curve has steepened the 5 year “only” down -24bp over the week. Forget the monetary policy needs to remain restrictive text, the OCR is currently at least 300-350bp over the neutral rate so it is restrictive and will so for some time. Rolling that all together August is now a live meeting, Q2 CPI released on Wednesday and the Labour market data on 7 August both pivotal in cementing or working against the pricing noted above.

To add to the above US CPI printed on the low side, adding to the conditions for the RBNZ to ease. The first -25bp FED cut is now priced into September with -60bp of easing priced in by years end, although the US election outcome is yet to run interference. All the ducks are starting to line up for an early RBNZ easing, Wednesday’s CPI release would need to be 3.60% or higher to generate a meaningful move in yields now…with most forecasting in the 3.3-3.5% range. Banks have started to reduce mortgage rates, which if becomes widespread will incrementally help as holder roll. However, RBNZ action is really needed to have an effect on the business community on floating borrowing…and it feels that’s where the suffering is.

NZ neutral OCR pricing is sitting around the 3.60% mark, around -0.20% lower than this time last week. Arguably still higher than where most see it settling in the long term, however the front loading of RBNZ cuts may mean less easing needs to be done later (in theory!).” Ross Weston, Head of Balance Sheet – Treasury.

In currencies, the MPR was a gamechanger for the Kiwi

“Last week we were expecting the MPR to be a bit of a ‘wait until the next MPS for further direction’, but this turned out not to be the case. After being relatively well supported the week prior, trading into the 0.6130-0.6170 levels, the Kiwi dollar certainly got a bit of a lid put on it with the dovish MPR. After hovering around the 0.6130 level, the Kiwi quickly sold off to 0.6070, pushing below the 0.6080 support level. We ended up getting a boost higher again, following the US CPI print, that was better than expectations. With the Fed now also priced to deliver cuts in 2024, the US dollar sold off, and the Kiwi managed to claw back to 0.6125. We open the week close to the 0.6100 level. This week is another important one for the Kiwi, with NZs Q2 CPI print due out on Wednesday. If we get the anticipated solid slowdown in inflation, then this will help to cement that view that we are indeed on track towards the RBNZ’s target range, then we anticipate the Kiwi will head back under the 0.6080 support level. Of course an upside surprise should see us track closer to current levels and above. The NZDAUD cross has tested the 0.9050/0.9060 levels, and continued to track lower throughout the week last week, down to 0.9013. The market still has an eye on the RBA for a potential hike, as Aussie inflation data continues to disappoint, although it seems a high bar to deliver a hike. The Aussie/Kiwi interest rate outlooks are certainly continuing to diverge for now, so if our CPI print delivers a good outcome on Wednesday, NZDAUD should track lower into the high 0.8900’s.” Mieneke Perniskie, Trader - Financial Markets.