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The O'Brien Column: Interest rates will matter more than CPI in central bank view

Friday 21st July 2000

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The June-quarter movement of 0.7% in the consumer price index should have been no surprise to anyone who is involved in investment, nor was the 2% increase for the year ended June unexpected.

Rising petrol prices, for example, have affected the index since late last year, rising 6.3% in the December quarter.

The overall increase of 25% in petrol for the year ended June, after a 4.5% lift in the June quarter, was a hefty jump and a solid contributor to the total rise in the CPI.

Everyone knew an increase in tobacco excise would affect the index and that was also built into forecasts.

The CPI is supposed to measure price changes in many goods and services so tobacco products are included, but there is a paradox there.

Discouraging smoking was part of the government's reason for lifting the excise on the products, irrespective of its effect on such an important economic indicator as the index.

Trade unions were suggesting on Monday the latest CPI figures could lead to pressure on wage rates.

If that happened New Zealand's smokers could be consoled that the higher cost of satisfying their habit had an effect, albeit small, on the incomes of the nation's toilets.

Rising petrol prices were a more serious matter, because petrol is part of every link in the production, distribution and retail chain.

An increase in fuel costs becomes cumulative as it passes through the chain and percentage margins are added to costs to reach a sale price, assuming operators do not absorb additional costs.

Many companies and sole traders absorbed part or all of recent petrol price movements but that cannot continue for much longer.

The Institute of Economic Research noted on Monday that the economic effect of a rising CPI would be either a higher "price breakout," or business emphasis on cutting costs, which could slow down growth and affect employment.

Other imported inflation is also working through to local prices in the wake of a decline in the dollar against the currencies of New Zealand's major trading partners.

The trade-weighted index (TWI) was 51.79 at the end of last week, compared with 54.50 on March 31 and 55.40 at the close of last year, declines of, respectively, 4.97% and 6.52%.

That was good news for exporters, after discounting the higher costs of imported inputs, but bad for importers and ultimately for buyers of imported goods, particularly goods in the higher price bracket where a relatively small percentage increase can result in a substantial dollar movement.

Investment markets will now wait and see what will happen to interest rates.

The Reserve Bank is due to set the official cash rate (OCR) in its quarterly statement on August 16 and there seems a variety of opinion among economists as to what it should do, with some wanting no change and others forecasting an increase from 6.5%.

Those views, although with the usual range of figures, were based on a combination of general inflation trends and the state of the overall economy.

It will be interesting to see what account the Reserve Bank takes of the higher excise tax on tobacco, for example, given that it is, so far, a one-off change and is a tax.

Any lift in the OCR obviously flows through to other interest rates, whether it is anticipated or not, and that affects share prices.

There is also the point that the bank looks ahead not back when it sets the rate, subject to the point that some price increases at parts of the chain have still to work their way through to the rest.

There was a minor, perhaps trivial, example of a potential price rise on the way with the news this week that West Africa's four main cocoa producers had decided to destroy part of their crop next season to overcome low world prices.

Such action could result in price hikes for chocolate and other products using cocoa that form part of our CPI.

There is probably some ironic justice in that situation, since cocoa-producing countries tend to be the poorer countries while most cocoa-based products are consumed in wealthier parts of the world.

The cocoa situation was an example of how international developments can affect matters in this country, but there are many others, particularly those emanating from the US.

Economic conditions in the US are still strong and the Federal Reserve will be looking at interest rates at a meeting a week after our Reserve Bank sets out OCR.

There is also the presidential election in November and the usual biennial election of the House and one-third of the senate.

Those events can affect US markets, if only because of any uncertainty about the outcomes. Our markets would not be immune from flutterings among US investors.

Release of the latest CPI figures are unlikely to do much for investment either way. What the Reserve Bank decides to do in August will have a much greater impact.

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