Exchange rate puts heat on NZ petrol prices

New Zealand's copious consumption of oil for transport makes it particularly vulnerable to global price shocks, the Reserve Bank says.

But on top of that, economists are picking the predicted "correction" by the New Zealand dollar this year as another speed bump for motorists and the wider economy.

Hurricanes, geopolitical unrest, a squeeze on refining capacity and burgeoning demand from China and India's fast-growing economies combined to send oil up to US$71 ($103.50) a barrel in late August. That threw fear into markets and economists and also siphoned cash from motorists' pockets.

The direct effects of price increases saw annual CPI inflation climb to 3.4 per cent, well outside the Reserve Bank's 1 to 3 per cent target range. The bank predicted inflation would hit 4 per cent early this year, but then dropped its forecast to 3.4 per cent over the next few quarters after oil prices fell.

Nevertheless, prices remain well up on the US$43 a barrel seen at the start of last year. Yesterday, it was trading at close to US$63 per barrel.

Meanwhile, analysis by one of the bank's own economists has highlighted New Zealand's relatively high reliance on imported oil for transport, which means it is vulnerable to big second and third-round effects from oil price rises - as inflation spills into other goods and services. That may trouble the bank as it seeks to bring inflation back within its target band over the coming year.

Felix Delbruck, writing in the Reserve Bank's latest bulletin, said a relatively large part of New Zealand's transport fuel use consisted of diesel and jet fuel, rather than petrol.

"Consistent with this, we calculate that the indirect effect of a change in oil prices on consumer prices (through higher costs of transport services and other goods and services, as opposed to the cost of petrol itself) could be quite large.

"How large these indirect effects turn out to be will depend very much on how persistent higher fuel prices are expected to be, the state of the economic cycle, and the degree of competition in individual industries."

Delbruck's analysis suggested the indirect impact of an oil price shock on consumer prices could be as large as the direct effect. But he said higher fuel prices could also reduce inflationary pressure in the medium term by dampening non-oil consumption.

ANZ economist Sean Comber said the bank was likely highlighting the fact that it could look through short-term direct effects from a spike in oil prices, "and to the extent that they're self-correcting by reducing demand, they may be able look through some of the second and third-round effects".

"But if those things don't generate a slowdown in demand, which is ultimately what the Reserve Bank has to do to contain inflation pressures, then they might need to do something with monetary policy."

BNZ senior economist Craig Ebert said slowing growth and higher inflation from oil price rises were a headache for the bank.

"What's the poor Reserve Bank to do? Do they react to the growth bit or do they react to the inflation bit? The reality, of course, is that they've got to keep an eye on both of them and it's never an easy task."

However, given the recent easing in prices, Ebert said oil was "more of a lingering issue rather than a heated one at the moment".

But there was another fuel-price issue to consider in the exchange rate.

"Fuel is a tradeable good so it depends very heavily where the exchange rate goes. Even if global prices have settled down there's still the potential for us to pay a lot more for our fuel because of our exchange rate."

ANZ's Comber said: "The strength that we've seen in the New Zealand dollar over the last year or so has provided some insulation to the economy from the impact of higher oil prices, but, obviously, if expectations about the currency over this year pan out, then that insulation is going to well and truly disappear."

Although Ebert pointed out that a lower kiwi would provide a welcome boost for the export sector, imports would be more expensive.

"That's effectively going to be a big cost of living jump for the household sector, and I think fuel is potentially going to be quite an important part of that. At the end of the day people spend a reasonable proportion of their pay on filling their cars up."


The bad oil
* For its size, New Zealand uses more diesel and jet fuel than most other economies.
* That means fuel prices are a more significant component of prices for a wide range of other goods.
* Fuel prices therefore feed into inflation more widely in New Zealand than elsewhere.
* The pending "correction" by the New Zealand dollar is set to raise the price we pay for oil.