Liam Dann: Why low prices are bad news

Photo / Bloomberg

Today's inflation data tells the story of the biggest problem facing the New Zealand economy. Prices for almost everything were flat or down last year -- with the glaring exception of housing costs.

If you don't own your own home that dollar or two you might save each week on vegetables, or the cut price deal you'll get on a new TV, aren't nearly going to compensate. And low price inflation also means low wage growth.

It is possible bigger weekly savings flowing through from petrol (one of the big drivers of the deflationary effect) might be starting to help but that brings with it other issues for the economy.

So, prices for new builds were up 5 per cent over the year -- 7.2 per cent in Auckland. Rents recorded an annual gain of 2.5 per cent.

Meanwhile overall consumer price inflation was up just 0.1 per cent and was actually down 0.5 per cent in the last three months of the year.

The mega-prices for houses themselves -- 8 per cent nationwide and 14 per cent for the Auckland region -- aren't even included in the Consumer Price Index data which sets the inflation rate.

Petrol prices were down 8.1 per cent for the year and made the largest downward contribution to the data. In the December quarter milk prices were down 6.5 per cent, partially reflecting the slump in commodity prices and vegetables were down 17 per cent, although much of that was seasonal.

Its not just struggling house hunters that will be feeling the squeeze if this trend continues.

Firms in the latest NZIER survey of business of business opinion this week noted that they were still struggling to pass on price increases to compensate for rising fixed costs like rent.

That squeezes their margins and starts to put a dampener on business expansion and economic growth.

The sluggish inflation data will certainly reinforce the view of ASB and Westpac economists, that the Reserve Bank needs to cut rates further this year -- both are tipping two more cuts taking the OCR to just two per cent.

The New Zealand dollar has fallen sharply this morning reflecting some market support for this view.

Broadly, business confidence at the end of last year showed growing optimism about the economy and it is not clear this low inflation trend will derail that but it does put growing pressure on both the Reserve Bank and the Government to give more consideration to stimulatory policies.

Bill English wouldn't call it stimulus because that sounds a bit "hands on" for National but don't be surprised to see the Government bring forward the timing of some big infrastructure spending this year.

That kind of policy shift and further cuts to the official cash rate would be in line with recommendations made by the International Monetary Fund yesterday as it down graded global growth projections and called for states to take a more proactive approach.

The IMF's latest report shows New Zealand certainly isn't out on its own on this issue with most Western economies facing persistently low inflation and the spectre of slowing Chinese demand keep a lid on prices.

The big debate amongst economists right now is whether this is a cyclical issue and inflation will return as oil and commodities bounce back or whether bigger structural changes to the global economy -- driven by technology and consumer behaviour -- mean the days of high inflation are gone for good.