Commodity rally may stoke inflation, Bollard says

Reserve Bank Governor Alan Bollard. File photo

Reserve Bank Governor Alan Bollard said accelerating inflation may force an interest rate hike if persistently high local commodity prices feed into consumer spending and borrowing habits.

Central bank research shows the price of locally-produced raw materials will remain elevated for some time, and Bollard yesterday told farmers in Ashburton that may create inflationary pressures with a strong kiwi dollar underpinning cheaper imports and amplifying returns on exports.

"If households and firms use the income boost from higher commodity prices and exchange rates to bring forward consumption and investment, or increase borrowing, then pressure on resources in New Zealand would lead to more inflationary pressure.

Bollard's warning comes in the midst of a local commodity boom, with the price of raw materials at record highs amid strong demand out of Asia for high protein foods and building materials. Inflation was 4 per cent in 2010, which partly reflected the hike in goods and services tax in October.

The central bank analysis points to growing wealth and urbanisation in developing economies for the increased demand in New Zealand-produced food in a structural, rather than cyclical, shift, meaning prices will struggle to fall away in the future.

With grain prices continuing to rise as more land is used to make bio fuels, New Zealand producers, who have high grain inputs, may see windfall gains, the bank said.

Still, prices may fall back in the short-term as global weather patterns settle down as the current La Nina episode weakens, and supply becomes less disrupted.

Bollard said their projections are still uncertain, with the path of commodity prices "fiendishly difficult to predict."