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CPI report takes centre stage

Monday 14th January 2008

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This week's CPI report will take centre stage, and should be enough to reinforce the RBNZ's tightening bias.

The REINZ housing market data, out this week, will provide further insight into the degree to which the market is buckling under the pressure of high interest rates, buyer caution, and reduced immigration.

The QVNZ house price report released this morning confirmed the market is in a downward spiral. The ANZ commodity price index tracked sideways in December. Nevertheless, the series remains 37% above the previous cyclical peak, and the outlook for the pivotal agricultural industry remains upbeat.

In other data, employment confidence slipped in 4Q as job seekers became pessimistic.

Global inflation is rising rapidly amid a significant growth slowdown. Global headline CPI inflation is on track to break 4% in the coming months, its highest level in over a decade. Core inflation looks set to move decisively above 2% for the first time during this expansion. This dynamic creates a difficult set of choices for policymakers. They recognize that part of the rise in inflation reflects the surge in energy and food prices, which may prove transitory and is helping to depress household purchasing power.

However, rising commodity prices also reflect a macroeconomic environment of four full years of above-trend GDP growth. It is thus not surprising to see most central banks responding cautiously to recent developments.

The fear of global stagflation, i.e., a sustained period of subpar growth and rising inflation, is relevant to this debate but is often poorly characterized. Given the lags between growth and inflation, it is normal for inflation to rise for some quarters after the global economy moves from strength to weakness. There are also structural changes that alter the growth-inflation trade-off across the business cycle.

This trade-off deteriorated in the 1970s amid a sharp fall in global potential growth; at that time, inflation rose rapidly following periods of strong growth while falling more modestly in the aftermath of recessions. While these trade-offs appear to be deteriorating this decade for the basic rule that inflation moves up and down in lagged response to sustained swings in growth has remained a constant for the US and global economy over the past four decades.

This view of the inflation process is central to Chairman Bernanke's signal last week that the Fed will move to an accommodative policy stance during the current quarter.

Source: JP Morgan press release

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