Key Takeaways:
New Zealand businesses are passing on cost increases more readily than in the past and are less likely to cut prices when costs ease, a dynamic the central bank warns risks turning temporary shocks into persistent inflation.
The Reserve Bank of New Zealand raised interest rates last week for the first time in its current easing cycle, and Chief Economist Paul Conway warned that businesses are passing on cost increases to consumers more quickly than in the past, raising the risk that temporary price shocks become embedded in inflation.
"Research suggests that New Zealand businesses pass on cost increases more readily now than in the past and are less likely to reduce prices when costs ease," Conway said in a speech to a business gathering. "All else equal, this raises the risk that temporary shocks become persistent inflation."
The warning comes as renewed Middle East hostilities and President Donald Trump's reimposition of a US naval blockade on Iranian shipping through the Strait of Hormuz pushed Brent crude up 9.6 percent to USD83.30 a barrel and West Texas Intermediate up 9.4 percent to USD78.14, wiping out a month of oil price declines. The RBNZ's rate increase — its first since beginning an easing cycle — came with economists warning that further hikes will be needed just to bring monetary policy back to a neutral stance.
The combination of oil-driven inflation shocks and domestic pricing behavior creates a dilemma for the RBNZ: if firms continue to pass through cost increases rapidly while refusing to cut prices when input costs fall, each energy price spike risks becoming a permanent inflation layer, requiring progressively higher interest rates to contain.
After a prolonged period of above-target inflation, anchored inflation expectations cannot be taken for granted, Conway said. The central bank's research indicates that New Zealand companies have structurally changed their pricing behavior during the high-inflation era, becoming more aggressive in passing on cost increases and less willing to offer price reductions when their own costs decline.
The shift has implications beyond New Zealand. Central banks across developed economies are watching for similar patterns as oil prices surge. Money markets have priced in about even odds of a Federal Reserve rate hike this month, with Fed Governor Christopher Waller saying officials may need to tighten if inflation stays firm. The US dollar strengthened against most currencies as the Middle East conflict fueled inflation fears, with the DXY index at 100.92.
Trump's blockade of Iranian ports, covering all vessel traffic regardless of flag, and the 20 percent toll on cargo shipped through the Strait of Hormuz represent a significant escalation. The UN shipping agency said there is no legal basis for mandatory tolls on strait transits. Brent crude's 9.6 percent jump was its sharpest daily gain since May 2020, reviving fears over energy shipments and stoking inflation worries globally.
For the RBNZ, the challenge is compounded by the timing. The central bank had been in an easing cycle before last week's hike, suggesting policymakers believed inflation was under control. The reversal signals that the pass-through pricing dynamic Conway described may already be forcing a more hawkish stance than anticipated. Economists now expect additional rate increases to bring policy settings back to neutral.
This article is for informational purposes only and does not constitute investment advice.
