Inflation heads to 10-year low

Inflation is expected to be down close to the bottom of the Reserve Bank's target band when the consumers price index is issued on Thursday.

The median forecast of September quarter CPI among 11 market economists surveyed by Bloomberg is 0.8 per cent.

That would pull the annual inflation rate down to 1.2 per cent, the lowest for a decade but as close as it is expected to get to dropping out of the central bank's 1 to 3 per cent target band.

It was 1.9 per cent in the June quarter after peaking at 5.1 per cent in September last year.

Westpac economist Doug Steel said that with the usual winter lift in vegetable prices food would make the biggest upward contribution, followed by transport, on the back of higher petrol prices and an increase in the ACC levy on car registrations.

Annual increases in alcohol excise and local body rates are seasonal factors in the September quarter, which also normally sees a rebound in international air fares.

In contrast to the pattern during the mid-decade boom years, inflation is expected to be higher in the tradeables sector, where it is influenced by international prices and the exchange rate, than in the domestic or non-tradeables sector.

Steel said Westpac had pencilled a 1.2 per cent lift in tradeables prices in the September quarter, reflecting the lagged upward effect on prices from the falling kiwi dollar early this year.

But the steep rise in the exchange rate since then would dampen tradeables prices over the coming quarters, he said.

Non-tradeables inflation is expected to be 0.7 per cent in the quarter, boosted by government charges, but to dip below 3 per cent on an annual basis for the first time since early 2002.

Another measure of underlying inflation - the CPI excluding petrol - was also expected to moderate, to 2.7 per cent from 3.8 per cent a year ago, Steel said.

Looking ahead Deutsche Bank chief economist Darren Gibbs expects the CPI to rise just 0.1 per cent in the December quarter, but that would still mean a lift in the annual rate to 1.8 per cent as the effect of a slump in petrol prices a year ago drops out.

A combination of generally weak global inflation and the rebound in the exchange rate would keep a lid on inflation in the tradeable goods sector for quite some time, he said.

But non-tradeables inflation would begin to turn gently higher towards the end of next year and into 2011 as the economy's spare productive capacity was gradually taken up.

As the CPI is a backward-looking indicator and the Reserve Bank sets interest rates on the basis of what it sees on the medium-term horizon, Thursday's numbers are expected to have limited implications for monetary policy.

"The short-term outlook suggests no urgency to hike interest rates," Steel said.

The level of economic activity in the June quarter was 2.8 per cent below its peak at the end of 2007, suggesting it would take some time before any recovery generated significant inflationary pressure.

"The key for monetary policy is to begin removing stimulus before the slack [in the economy] actually dissipates, given the lags involved.

"With the economy now in recovery mode and forward-looking indicators sharply higher, we think rate hikes will be on the agenda around mid-2010 or a touch earlier," Steel said.

CPI

* 0.8 per cent expected for the September quarter.
* That means annual inflation is down to 1.2 per cent, the lowest in 10 years.
* But that's as close as it's expected to get to the bottom of the Reserve Bank's 1 to 3 per cent target band.