Lower than expected inflation data yesterday is both good and bad news, with less pressure on the Reserve Bank to tighten the interest rate screw and more affordable shopping - albeit as a reflection of a sluggish recovery.

The consumers price index, which measures the changing price of a fixed basket of goods and services, fell 0.3 per cent for the December quarter and rose 1.8 per cent for the year compared with 4.6 per cent for the 12 months to the September quarter.

Statistics NZ prices manager Chris Pike said a larger than usual fall in vegetable prices, which were down 25 per cent in the quarter, reflected a shortage of supply in the three months to September.

"Basically, vegetable prices were higher than normal last winter, then fell to normal levels towards the end of the year."


Telecommunication services was down 3.6 per cent, reflecting higher data caps, lower prices for broadband plans and lower international calling rates from landline phones.

On the flip side, transport was up 1.4 per cent in the quarter, with international air fares - which show seasonal increases - up 5.8 per cent, petrol up 0.9 per cent and second-hand cars up 1.8 per cent.

Unlike the previous four quarters, the latest annual increase in the index of 1.8 per cent did not include most of the effects of the October GST increase.

Goldman Sachs economist Philip Borkin said the latest quarterly data had delivered a large downward surprise.

"Against a backdrop of global downside risks and moderating domestic economic momentum, this benign inflation backdrop provides the [Reserve Bank] with more flexibility to respond."

Goldman Sachs' view was the next change in interest rates would be up, from the fourth quarter of this year, but there was less standing in the way of easing if global or domestic economic conditions proved weaker than expected, he said. All else being equal, soft inflation allowed the Reserve Bank to either do nothing or potentially even cut rates, which could be viewed as positive.

"There's also the fact that the soft inflation environment is just a reflection of the fact that the recovery to date has been relatively sluggish and there's still spare capacity out there and firms are finding it difficult to pass cost increases on because demand's soft."

New Zealand was not immune to the weakness around the world and the country was also going through a structural adjustment, Borkin said.


"We're paying down debt and the Government are also now about to pay down debt so there's some domestic conditions as well that will continue to weigh on activity.

"Certainly if price pressures are lower that is a small real boost to households' disposable incomes but the way the last 24 months have been it's really been reflected in household savings rather than spending growth."

Deutsche Bank said the Reserve Bank would doubtless welcome the return of headline inflation to comfortably inside the 1 to 3 per cent target band.

"We think the soft inflation print adds weight to our view that in the current uncertain economic environment there is unlikely to be a need for domestic monetary policy tightening until later this year at the earliest," Deutsche Bank said.

ASB said that, as expected, the decline in tradable inflation was driven by a fall in food prices over the quarter.

"Nevertheless, tradable inflation was weaker than expected, reflecting subdued demand in the retail sector.

"While the high NZ dollar over the second half of 2011 has allowed retailers to discount the price of big-ticket items such as furniture and electronic goods, the extent of price declines in these items over [the December quarter] is greater than recent currency movements would suggest."

The relatively broad-based nature of muted inflation suggested very little for the Reserve Bank to start worrying about on the inflation front, ASB said.

"In particular, the weak extent of construction-related inflation in the second half of 2011 highlights that the bow wave of earthquake rebuild inflation has yet to appear."

ASB expected the Reserve Bank would wait until December before gradually lifting the Official Cash Rate but the risks were skewed to a later start "particularly if reconstruction looks like it will be delayed from our expectations of a mid-year start".