KEY POINTS:
Better-than-expected inflation figures have reduced the likelihood that Reserve Bank Governor Alan Bollard will raise the official cash rate next Thursday.
The consumer price index fell 0.2 per cent in the December quarter, bringing the annual inflation rate down to 2.6 per cent from 3.5 per cent three
months ago.
It ended an 18-month period outside the bank's 1 to 3 per cent target zone.
The drop was largely caused by a 15 per cent fall in petrol prices, without which the index would have risen 0.6 per cent.
More significant, economists said, was a long-awaited drop in non-tradeables inflation, which relates to domestic sectors not affected by the exchange rate and international prices.
Non-tradeables inflation has been at or above 1 per cent a quarter for more than two years, but it fell to 0.8 per cent in the December quarter.
In the tradeables sector, prices fell 1.3 per cent in the quarter, reflecting lower oil prices and the effect of a high New Zealand dollar.
"It has bought the Reserve Bank some time," said Westpac chief economist Brendan O'Donovan.
"It is finally getting some traction from a long period of tight monetary conditions. This is what had been perplexing it - how persistent high non-tradeable inflation has been."
The financial markets had priced in a better-than-even chance that Bollard would increase rates next week.
But as soon as the figures came out, that was scaled back to a 40 per cent chance, and the kiwi dollar dropped accordingly.
It fell as low as US68.87c but recovered to end the day at US69.17c.
O'Donovan said a rate increase was still possible in the June quarter.
But the Reserve Bank would take comfort from the prospect of lower inflation expectations as the actual rate declined - perhaps to 1.5 per cent by mid-year.
"In addition the dollar is about 5 per cent higher on a trade-weighted basis than the bank's forecasts assumed," O'Donovan said.
"So the Governor has time to see whether the rebound in activity that is happening is temporary or more persistent."
But the Bank of New Zealand's head of research, Stephen Toplis, and Deutsche bank chief economist, Darren Gibbs, believe Bollard ought to lift the interest rate, although they do not expect that he will do so.
Toplis believed inflation would fall to 1.3 per cent by June, which would drag down inflation expectations. That, in turn, would help cap future inflation.
"But that will all be in vain if the Reserve Bank does not start leaning against the growing signs of resurgent demand and in so doing put the inflation genie back in the bottle."
Gibbs said a rate rise was needed to accelerate the correction of imbalances in the economy, "allowing room for a sustained reduction in the value of the New Zealand dollar".