Brian Fallow: Consumers just have to grin and bear it

Ultimately the consumer has to match the world prices for the stuff our farmers grow. Photo / Greg Bowker

Pity the poor consumer, caught between government policies driving up the cost of living on one side and resurgent global oil and food inflation on the other.

The December quarter inflation numbers due from Statistics New Zealand this morning will be the first to reflect the impact of the increase in the GST rate from 12.5 to 15 per cent on October 1.

Market economists and the Reserve Bank expect the consumers price index to jump 2.3 per cent in the quarter, pushing the annual inflation rate to 4 per cent.

The GST increase, if fully and immediately passed through, would raise the CPI 2 per cent.

But for many firms it is a case of chance would be a fine thing. Their pricing power is constrained by weak demand and lingering caution on the consumer's part.

ASB economist Christina Leung says the anecdotal evidence on whether the GST increase has been passed on is mixed.

Some firms have chosen to absorb it into their profit margins, while others have taken the opportunity to review their prices more generally, usually resulting in a rounding up of price increases.

But at least the increase in the GST rate, like the impact of the emissions trading scheme on fuel and electricity prices the previous quarter, is an event rather than a trend, a wave rather than a tsunami.

In that sense the more ominous development, at least from the consumer's point of view, has been what has been happening to oil and food prices globally.

According to the Ministry of Economic Development the price of petrol at the pump rose 34c a litre or just under 21 per cent in 2010. Diesel rose 25 per cent.

The GST increase and ETS account for only a minority of that. It was driven most of all by a 13 per cent rise in the cost of crude oil over the year in New Zealand dollar terms.

With growth in the global demand for oil driven by the powerhouse economies of Asia it looks like only a matter of time before we see oil at US$100 a barrel. As New Zealand imports three times as much oil as it exports, that is unambiguously negative for the economy.

Soaring world prices for food commodities is a different story.

The UN Food and Agriculture Organisation's food price index has now topped the vertiginous heights it reached three years ago, sparking food riots in a number of countries. It rose 25 per cent over 2010.

Stocks are not at critical levels but the supply/demand balance is tight enough to heighten vulnerability to adverse climatic events like the Australian floods.

New Zealand's commodity exports, as measured by ANZ's index, rose 23 per cent last year in world price terms.

The high exchange rate gobbled up about a third of that increase, but even in New Zealand dollar terms the commodity price index rose 16 per cent last year, compared with just 2 per cent in 2009 and no rise at all in 2008.

The net effect is multi-decade highs in the terms of trade - relative prices for the kinds of things we export as against the kinds of things we import - boosting national income and making it easier to earn our living as a trading nation.

But tell a consumer "the bad news is that petrol prices are going through the roof but the good news is meat and dairy prices are too", and you are liable to elicit a bitter and derisive snort.

So far the impact of global food price infusion on the consumer has been reasonably contained. Statistics NZ's food price index on average over the past three months was 4.7 per cent higher than in the same period of 2009.

But ultimately the consumer has to match world prices for the stuff our farmers grow.

Another side of the inflation story is China, whose annual inflation rate topped 5 per cent in November.

New Zealand may well see a similar rate later this year. But the social implications are quite different.

As an official of the People's Bank of China, its central bank, said last year, it is low-income city dwellers and migrant workers who are hardest hit by inflation. In China's case those two groups represent an awful lot of people.

Measures the central bank has take to tighten monetary policy so far have reined in credit growth, but only to around 20 per cent, still a galloping pace even in an economy whose real economy is expanding at about 10 per cent.

Hence the expectation the Chinese authorities will continue to tighten and the hope (probably forlorn) that they will allow the renminbi to appreciate a bit more rapidly, which would also reduce inflationary pressure.

The risk, of course, is that they overdo the tightening and instead of a soft landing we see China's growth rate drop with an undercarriage-buckling thud.

For all that, the Reserve Bank appears to be relaxed about the inflation outlook - or as relaxed as an inflation-targeting central bank can ever be.

Relaxed enough, in any case, that market economists now expect it will be September before it increases the official cash rate.

The bank's December forecasts had the inflation rate spiking to 5 per cent in June but dropping back swiftly to about the mid-point of its 1 to 3 per cent target range by the end of the year.

It thinks that most of the 4 per cent inflation rate it expects to be announced today can be laid at the door of government policy changes - GST, the ETS and tobacco tax increases.

Excluding them it thinks the annual inflation rate would be just 1.4 per cent for 2010, and set to stay around the mid-point of its target range over the next couple of years.

Underpinning that view is the amount of slack or spare capacity in the economy, of which the starkest indicator is an unemployment rate of 6.4 per cent.

There is plenty of scope for demand to increase before running into bottlenecks and supply constraints. The bank does not expect this output gap, as it is called, to be closed until 2013.

This judgment may be excessively sanguine, as some private sector forecasters believe.

But in the meantime the bank has assured us that "for now it seems prudent to keep the OCR low until the recovery becomes more robust and underlying inflationary pressures show more obvious signs of increasing".