Inflation set to go up a gear

Inflation in December quarter is driven mostly by a rebound in fuel prices. Picture / Duncan Brown.

Inflation looks set to pop back into the Reserve Bank's 1 to 3 per cent range after a two-year absence.

Statistics NZ's consumers price index (CPI) is due out on Thursday and economists expect that inflation came in a just over 1 per cent in calendar 2016, driven mostly by a rebound in fuel prices.

Bank economists said that the days of abnormally low inflation are fast nearing their end, but they don't necessarily see it taking off either.

Central banks get nervous when inflation heads towards zero as a dip into negative territory, or deflation, risks deflationary spirals and recessions.

In New Zealand's case, inflation has been sailing perilously close to zero for more than two years, precipitating seven cuts in the Reserve Bank's official cash rate, the last move move being a 25 basis point cut to a record low of 1.75 per cent in November.

CPI inflation came in at just 0.4 per cent in the September 2016 year and fell to just 0.1 per cent - the lowest point in 16 years - in calendar 2015.

The last time inflation was within in the Reserve Bank's mandated 1 to 3 per cent range was in the September 2014 year, when it registered a 1 per cent gain.

Westpac expects Thursday's release to show a 0.2 per cent rise in the index for the December 2016 quarter, taking the year's gain to 1.2 per cent.

"The Reserve Bank will take some comfort from a return to the 1-3 per cent target band," Westpac said.

"But the renewed strength of the New Zealand dollar means that inflation will remain subdued for some time yet," the bank said.

World oil prices plunged in 2014 and 2015, contributing to the "undershoot" in New Zealand's inflation rate over that time.

A steep 7 per cent fall in petrol prices in the December 2015 quarter will now be dropping out of the annual calculation, to be replaced by a 4 per cent rise over the December 2016 quarter, Westpac said.

But even after stripping out fuel prices, the picture is still one of increasing inflation.

Inflation bottomed out at the end of 2015 and has been picking up gradually since, though it remains low relative to history and to the 2 per cent midpoint of the Reserve Bank's target range.

"Once inflation returns back within the target band, the Reserve Bank will have less reason to worry about inflation expectations becoming unanchored," Westpac said.

"But with inflation still dwelling at the lower end of the target range, and likely to do so for a while longer, there's no case for withdrawing the monetary stimulus that the RBNZ has applied over the past couple of years," it said.

The Reserve Bank itself sees inflation hitting 1.3 per cent in the year to March, 1.6 per cent in 2018 and 2.1 per cent in 2019.

Bank of New Zealand senior economist Craig Ebert said the bump up in inflation would come as some relief to the Reserve Bank "because it has been so focused on the headline CPI to guide its policy".

"Formally, it will be back in the band for the first time in quite a few quarters," he said.

BNZ expects inflation to pick up to 2 per cent in the March year.

"We think the inflation rates have probably passed through their low points for the mean time," Ebert said.

Despite the lift in annual inflation, ASB said downside risks remain because of the ongoing impact that continued strength in the New Zealand dollar has on prices.

"The Reserve Bank may be relieved to see inflation back within the target band but, in our opinion, enough downside risks remain for the Reserve Bank to keep the OCR on hold for the foreseeable future," ASB said.