Economists fear deflation because falling prices lead to lower consumer spending, which is a big part of economic growth.
Companies respond to falling prices by slowing down their production, which leads to layoffs and salary reductions.
From the Reserve Bank's perspective, it's not inflation pressures today, but inflation pressures over 2021 that the Reserve Bank will be most concerned about – as inflation is a lagging economic variable, ASB Bank said.
"Deflation risks cannot be ruled out, which will make the RBNZ nervous given the limited the effectiveness of the OCR, which is now stuck at its operational lower bound," ASB economists said in a commentary.
"For now, it appears the economy has recovered from lockdown faster than expected."
The key is how well activity and confidence hold up over the rest of the year as the labour market weakens, sending unemployment higher and weighing on wage growth.
"Should the economic outlook deteriorate more than expected from here, we believe the Reserve Bank will prefer to use its Large-Scale Asset Purchase programme (bond buying) and other policy options, over a negative official cash rate," ASB said.
Kiwibank economists expect inflation to fall below 1 per cent by the year's end.
"The tyres of the Kiwi economy are deflating. But Covid-19 has caused a large puncture - deflation," Kiwibank said.
Oil prices slumped over the June quarter as the Covid-19 pandemic drove a sharp fall in the demand at a time when Saudi Arabia and Russia were involved in a price war.
In today's release, Stats NZ said food prices rose 1.1 per cent, influenced by higher vegetable prices (up 16 per cent).
Housing and household utilities rose 0.6 per cent, driven by higher prices for rentals for housing (up 0.6 per cent).
Stats NZ said the Covid-19 pandemic and subsequent alert level response created some interruptions in data collection and methodological challenges for the quarter CPI.
"They have also created a lot of volatility in the data," the department said.
The Reserve Bank has set its official cash rate at its lowest ever level of 0.25 per cent and has embarked on a $60 billion bond-buying programme to keep interest rates low in order to stimulate a pandemic-hit economy.
Westpac said the result did not alter its view that the Reserve Bank would need to keep monetary settings loose for a long period.
"We think that weak demand will trump supply-side disruptions over the medium term, leading to lower inflation pressures, and the economy is likely to remain below full employment for years to come," the bank said.
