Auckland city business and economy report 2007

Executive summary | Relative economic performance | Economic structure | Affordable housing | Population | Labour market | Retail trade and tourism | Building and property | Inflation, interest rates and the exchange rate | Potential economic impacts of climate change | Economic outlook

Inflation, interest rates and the exchange rate

The past year exhibited strong inflation driven by persistent levels of domestic demand. Inflation reached 4 per cent in June 2006, well outside of the Reserve Bank's target band of 1 to 3 per cent, before returning to 2.5 per cent in March 2007.

Inflation can be analysed as tradable and non-tradable inflation. Non-tradable covers price rises in goods and services that cannot be exchanged with other countries (eg dining out), while the tradable component includes goods that are, or could be, traded.

The high rate of inflation experienced in 2006 was the result of strong domestic demand for non-tradable goods. Non-tradable inflation was consistently around 4 per cent over the year to March 2007 meaning fluctuations in the headline rate of inflation came from the pressures of tradable inflation. In the nine months to March 2007 the decreasing tradable pressure and fall in overall inflation was primarily the result of a stronger New Zealand dollar.

After consecutive increases in the official cash rate (OCR) to control inflation from January 2004 to October 2005, the Reserve Bank had not changed the OCR until March 2007 when it raised it to 7.5 per cent, with subsequent rises to 7.75 per cent in April and 8.0 per cent in July.⁸

The Reserve Bank is not expected to raise interest rates any further as inflation is back within the target band. However, any drop in interest rates is unlikely before early 2008.

Inflation Annual percentage change

Source: Please note forecasts are based on an OCR of 7.75%

New Zealand interest rates are the highest in the developed world. High interest rates attract foreign capital, increasing the value of the dollar, and placing strain on exporters. The value of the dollar is at levels that have rarely been experienced since the currency was floated over 20 years ago.⁹

Between June 2006 and March 2007, the New Zealand dollar increased in value against the British pound by 3.2 per cent, the Australian dollar by 6.3 per cent, and on a trade weighted basis by 9.5 per cent. The most substantial rise of 11 per cent rise against the US dollar was partly a reflection of the strengthening of the New Zealand dollar, and partly a symptom of an overall weakness in the US dollar against all foreign currencies.

The New Zealand dollar is sitting 23 per cent above its 10-year average against the US dollar, and 3 per cent above the 10-year average against the Australian dollar.⁹

The New Zealand dollar is not expected to depreciate until the Reserve Bank begins (or is expected to begin) to loosen monetary policy.

Interest and exchange rates

Source: Reserve Bank of New Zealand 1 Official cash rate is value in last week of the month $NZ vs $US in monthly average.

Published June 2007