Low inflation fuels talk of cut in cash rate

The drop in the consumers price index has been largely due to the slump in oil prices. Photo / Peter Meecha

CPI fell by 0.2% in the December quarter, below Reserve Bank’s forecast of a 0.1% rise.

Inflation dropped below the Reserve Bank's annual 1 to 3 per cent target range in calendar 2014, extinguishing beyond doubt any expectations of an increase in its official cash rate this year and prompting talk that the next move could instead be a cut.

The consumers price index (CPI) fell 0.2 per cent in the December quarter, below both the market consensus of a flat outcome and the Reserve Bank's forecast of a 0.1 per cent rise, driven mostly by lower oil prices.

Annually, CPI inflation fell to 0.8 per cent from 1 per cent in the September year, and just below the bottom end of the bank's all-important target range. At that rate, it was the 13th successive outturn below the 2 per cent midpoint of the inflation target.

The Reserve Bank's legislation allows it to "look through" extraordinary conditions such as the current slump in oil prices, but a very low inflation outlook would test the central bank's mettle, said the Bank of NZ.

At its last monetary policy statement in December, the Reserve Bank kept its official cash rate at 3.5 per cent but communicated a tightening bias.

But based on yesterday's data, both ASB and ANZ said the Reserve Bank could rule out rate rises for the foreseeable future, while Westpac pushed its rate-hike forecast out to June 2016.

Economists did not raise alarm bells about the risk of deflation, but said the CPI release would nevertheless prompt talk of the next move being a cut and not a rise.

The BNZ said New Zealand's case was quite different from the situation in Europe, where falling prices were a result of a weak economy, weak demand and excess capacity.

"We suggest that Europe's case calls for monetary easing, New Zealand's situation does not," it said.

ANZ said debate would only intensify about whether there had been a structural change in the evolution of inflation.

"But certainly the CPI report confirms that there is no reason for the Reserve Bank to maintain their tightening bias at next week's official cash rate review," ANZ said.

Westpac said the recent sharp decline in petrol prices was set to cause a 0.4 per cent decline in the March quarter CPI.

"That will take inflation to only a whisker above zero. Nil inflation will torpedo any lingering notion of the Reserve Bank hiking the official cash rate in the near term, and could even cause financial markets to begin assessing the risk of official cash rate cuts," Westpac said.

Underlying inflation is still expected to rise gradually as the economy continues to grow, but further interest rate hikes could be delayed for some time.

"We don't think the Reserve Bank will cut rates, or even entertain the idea, on the basis of low inflation alone. However, we wouldn't dismiss this possibility altogether," Westpac said.

Expectations of a low CPI have put downward pressure on the New Zealand dollar this week. The currency dropped to US76.3c just after the CPI release, having started the week at around US78c. The kiwi regained ground near the close of local trade, finishing at US76.6c.

Q&A

What is deflation?
The persistent decline of prices.

Is New Zealand experiencing deflation?
No, according to Westpac chief economist Dominick Stephens.
The consumer price index in the December quarter fell by 0.2 per cent, with annual inflation sitting at 0.8 per cent. "I wouldn't normally expect it to be called deflation until annual inflation was below zero," Stephens said.

Why is deflation bad?
Persistent deflation is bad because consumers hold off on spending as they expect prices will keep falling. This can be harmful to economic growth. Deflation also means nominal debts grow in real value over time.

But should we be worried?
Stephens doesn't see New Zealand in this situation. Rather, he says the country is experiencing an "oil shock". "The nation's import bill has dropped, that's going to reduce prices for consumers and it means basically their wages are going further," he said. While inflation could get very close to zero next quarter, a one-off dip below zero doesn't constitute deflation in the way a country such as Japan has experienced it, Stephens said. Japan was gripped by deflation in the 1990s when bank lending dried up and the country has been battling it since. While this threat didn't loom over New Zealand, Stephens said the clouds were darker for Europe, which is at risk of slipping into persistent deflation.