Chapter 1: Why are inflation expectations so crucial right now?
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I'm Mark Lister, Investment Director at Craig's Investment Partners, and I'll be talking about a range of topics including economics, portfolio strategy, investor education, and anything else that's happening out there in financial markets.
G'day team, hope you're all well. It is Reserve Bank Day today, so I wanted to talk about the most important topic for
Chapter 2: How do inflation expectations influence consumer behavior?
for the Reserve Bank right now, because it might surprise you what they're watching most closely. We've seen a lot of economic releases over these last several weeks. We've had the CPI, the Consumer Price Index, we've had retail sales, we've had housing market data, we've had a mountain of releases. However,
The most important ones of all were probably two that came out last week, and these covered inflation expectations. Now, it might sound slightly odd that what people think might happen trumps what is actually happening. out there across the economy. But right now, that is very much the case. Expectations matter because they influence behaviour, and behaviour drives outcomes.
And that is especially so when it comes to inflation.
Chapter 3: What recent surveys reveal about expert inflation expectations?
If enough people expect prices to rise, there is a risk that they will then start behaving in ways that will ensure that those prices do rise. Workers will push harder for pay rises because they're expecting their own living costs to keep going up. Businesses will lift their prices that they're charging customers because they're expecting their own costs to rise too.
And consumers will start to think about bringing forward the purchases of goods if they're able to. If you know that that item you need will cost more next week and even more next month, next quarter, you will buy it today to avoid those price hikes if you can.
Now when that all happens at the same time, inflation expectations can become self-fulfilling, and that is why central banks spend so much time worrying about them. As well as keeping today's inflation under control, the Reserve Bank, remember, is also trying to convince all of us together that inflation will remain low and stable in the years ahead.
And that is what it means when it talks about keeping inflation expectations anchored. It needs to win that PR battle with consumers, with businesses and with financial markets so that we all keep our behaviour in check. Now, last week, the Reserve Bank released two separate surveys that looked at this inflation expectations.
Chapter 4: How do households' inflation expectations differ from experts' views?
The first one canvassed around 40 economists, business leaders and professional forecasters, the experts, you might say, while the other surveyed more than a thousand New Zealand households. And the good news is that the experts are still relatively relaxed. Unsurprisingly, this group has raised its collective view about where short-term inflation is going, and that's understandable.
That's on the back of higher fuel prices, supply chain disruption, and so forth. But more importantly, longer-term expectations remain pretty well anchored. Five-year inflation expectations from this group of experts are sitting at around 2.2%. Now, remember that the Reserve Bank has a target range of 1% to 3%. And the midpoint of that range is 2%. So they're pretty much aiming for two.
And over the next five years, the experts think it'll hit 2.2.
Chapter 5: What historical context shapes current inflation perceptions?
So pretty close to two, right? 10-year expectations from this group, lower again, just above 2%. So that is good news. The Reserve Bank will really take comfort in that. That will tell them that people who spend their lives living and breathing the economy and financial markets and inflation indicators, they believe that the system is working.
and they believe that inflation will eventually settle back to something more normal and stay there. Then again, it's not the opinion of this group that matters most. We're not all financial market experts and economists, are we? Thankfully. So that type of person doesn't drive the economy.
Chapter 6: Why is the Reserve Bank focused on inflation expectations?
The average household drives the economy, and the household survey painted a slightly different picture. The typical New Zealand household still expects inflation to be around 5% a year from now, and 4% in two years' time. That is higher than what the experts think. Even looking out five years from now, households still expect inflation to be running much hotter than the Reserve Bank would like.
And you can understand why. Most people don't experience inflation by looking at the official statistics or through the lens of their spreadsheet model. They see it when they're fueling up the car, when they're paying the rates bill, the insurance bill, or when they're checking the supermarket receipt.
And until 2021, pretty much no one under 50 had experienced genuinely high inflation pressures because their whole adult life we'd seen low inflation. Yes, they were children back in the 70s and 80s maybe, but they probably weren't paying the bills back then.
Chapter 7: What indicators is the Reserve Bank monitoring to manage inflation?
So their worldview has been shaped by a low inflation world. New Zealand inflation was low in the three decades leading up to COVID. It averaged about 2% annually in those 30 years between, let's say, 1990 right up to 2020, 2%.
it only pushed above that level for very brief periods but since covid as we all know it's been closer to five percent per annum much higher these last five years or so and once people have lived through that sort of cost of living shock that experience lingers and it's still very fresh in our minds so just when we thought things were coming under control we've now got another shock that has emerged and households are very much braced for that they know what might come next
And those perceptions matter. So none of that means that this rampant inflation that some are talking about is a foregone conclusion, because it's not. But this does help explain why the Reserve Bank is so focused on inflation expectations, why it's on high alert, and why it's watching expectations so closely.
If it can convince all of us as a group, not just the economists, but all of us out there, that the fuel price shock will be temporary and isolated and that they will get inflation under control over the next little while, then we'll all calm down, you won't see that behavioural change and all will be well or better than it could be.
But if households lose faith in the Reserve Bank's ability or their resolve and commitment to keeping broader price pressures in check, that will make its job much, much harder. So that is why it is watching everything out there. It's watching the housing market. It's watching the labour market. It's watching activity indicators.
It's watching the official inflation figures, but it's watching very, very closely firms' pricing intentions and consumer inflation expectations. Those things matter a lot. So that's all for today. I hope that's useful. Thanks for listening, team. As always, enjoy your week.
We'll talk again soon.
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