New Zealand's annual pace of inflation slowed to below the Reserve Bank's target band in the final three months of the year, giving governor Graeme Wheeler more room to keep the benchmark interest rate lower for longer.

The consumers price index fell 0.2 percent in the three months ended Dec. 31, from a quarterly increase of 0.3 percent in the September period, and below expectations for flat prices in the quarter, according to Statistics New Zealand.

That slowed the annual pace of inflation to 0.8 percent from a pace of 1 percent in September, and below the Reserve Bank's target band of between 1 percent and 3 percent.

The New Zealand dollar fell to a two-week low 76.20 US cents from 76.61 cents immediately before the 10:45am release, and was recently trading at 76.43 cents.


Traders are pricing in a reduction of 2 basis points to the 3.5 percent official cash rate over the coming 12 months, according to the Overnight Index Swap curve, indicating they see a chance of a cut by the central bank.

"The market now feels that at the very least the Reserve Bank is on hold until the end of 2016," said Warren Potter, senior portfolio manager at AMP Capital Investors New Zealand.

"They won't necessarily want to go too soft in terms of their rate view because they don't want to reignite the housing market, so they're in a bit of a dilemma and may start looking at macro-prudential things."

A 5.7 percent drop in petrol prices led the decline, with 91 octane fuel averaging $2 a litre in the quarter, as global oil prices slump in the face of mounting competition between the Organisation of Petroleum Exporting Countries and newcomers such as US shale gas producers.

That caused the tradable component of CPI, which includes goods and services that compete with international rivals, to drop 0.8 percent in the quarter, its biggest quarterly decline in three years, for an annual fall of 1.3 percent.

AMP Capital's Potter said the falling oil price was expected to have more of an impact in the first three months of this year, but the data showed it fed into the December period as well.

Bank of New Zealand economists this month tipped New Zealand to report two quarters of deflation, the first six-month period of falling consumer prices since 1998/99, though was less concerned about the wider ramifications on the economy which is expected to keep growing at a faster than expected pace than its developed nation peers this year.

Still, the New Zealand Economic Institute of Research's quarterly survey of business opinion yesterday cited a reluctance among firms to increase their prices this year, leaning on expected profitability.

The persistent strength in the New Zealand dollar is one of the causes for the tepid pace of inflation as it makes imported goods and services cheaper and has troubled the Reserve Bank which sees the currency as being unjustifiably and unsustainably high. The central bank paused its tightening cycle last year as the currency remained strong and as inflation was more muted than expected.

The non-tradable component of CPI, which measures domestic inflationary pressures, increased 0.3 percent in the quarter, slowing from a 0.5 percent pace in September, for an annual increase of 2.4 percent.

A 1.7 percent increase in the price of newly built housing for a 5.4 percent annual lift underpinned the increase in non-tradable inflation. A 2.8 percent quarterly rise in new Auckland housing prices and a 7 percent gain in the year led the increase.

The ebullient Auckland housing market has been problematic for the Reserve Bank, which imposed home loan restrictions on low-equity mortgages in late 2013 as a means to try and cool the property market without resorting to higher interest rates too soon, and along with higher interest rates helped moderate higher house prices last year.

Rental price increases were more modest at 0.3 percent in the quarter and 2.1 percent in the year.

A 0.7 percent drop in food prices in the December quarter added to the deflationary effect over the period, with a 7.5 percent decline in the price of fruit and vegetables, a smaller than normal seasonal decline. Food prices were up 0.5 percent on an annual basis, with a 0.9 percent fall in grocery food prices.

Cheaper telecommunications equipment also weighed on the headline figure with a 12 percent fall in the quarter taking the annual drop to 30 percent.

Part of that came from increased discounting of the goods in the period. Audio-visual and computing equipment prices were also down, falling 6.4 percent in the quarter for a 14 percent annual decline.

Domestic air fares rose 8.3 percent in the quarter driven by high demand in the lead up to the holiday period, and taking the annual increase to 6.5 percent.

International air fares rose 7.3 percent and package holidays were up 5.3 percent. On an annual basis, international air fares were unchanged and package holiday prices fell 3.6 percent.

Electricity prices fell 0.5 percent in the quarter, taking the annual increase to 3.6 percent.