Tame inflation expected to keep rates on hold until March

Interest rates are expected to remain on hold until March. Picture by David White.

The Reserve Bank and market economists are near agreement that inflation remained tame in the fourth quarter, keeping intact expectations that the official cash rate doesn't need to rise from a record low until March.

The consumers price index fell 0.1 per cent in the final three months of 2013, for an annual rate of 1.5 per cent, according to a Reuters survey of 11 economists. The Reserve Bank forecast a 0.2 per cent decline in the quarter for an annual 1.4 per cent in its December monetary policy statement. The data is due for release on Jan. 21.

Fourth-quarter inflation is typically weak because of a seasonal decline in fruit and vegetable prices. The latest quarter was also characterised by a decline in prices of petrol and diesel, while the trade-weighted index near a record high has ensured tradables inflation has been non-existent. That means the Reserve Bank's focus is on strength in non-tradable inflation, especially from a resurgent housing market.

"Domestic inflation pressures are gradually re-emerging, but barring a substantial upside surprise in next week's inflation figures, the Reserve Bank will have time to respond at a measured pace," said Michael Gordon, senior economist at Westpac Banking Corp. "Our view is that the CPI figures alone are unlikely to be the catalyst for an early move."

The December MPS forecasts annual inflation to stay below the central bank's 1 per cent-to-3 per cent target band until the fourth quarter of 2015 and Westpac's Gordon says he agrees that headline inflation will remain subdued over the coming year.

That leaves the economy in something of a sweet spot, with gross domestic product expected to grow 2.8 per cent in the year ending March 31, picking up to a 3.1 per cent pace in 2015, according to the New Zealand Institute of Economic Research's consensus forecasts in December. Business confidence rose to a 20-year high last quarter, the NZIER's quarterly survey of business opinion showed.

"Everything feels just about right," said Shamubeel Eaqub, the NZIER's principal economist. "We've got good growth in the economy, jobs are coming through and prices are not very high. But if it keeps accelerating then it will lead to price inflation and interest rate increases."

The QSBO shows a slight decline in firms seeing rising costs, while those reporting an increase in selling prices rose to 10 per cent from 8 per cent and for the coming quarter held steady at 24 per cent. The survey also indicates the economy has some headroom to grow without getting steamed.

Capacity utilisation slipped to 90.2 per cent in the fourth quarter from 91 per cent three months earlier, while those seeing capacity constraint climbed to 12.7 per cent from 10.8 per cent.

"Capacity utilisation has picked up but most of the pressures are in Canterbury," Eaqub told BusinessDesk. "The rest of New Zealand is at historic averages. Any growth from here will soak up excess capacity and lead to higher prices down the track, typically in six to 12 months."

The Reserve Bank next reviews interest rates on Jan. 30 and out of 17 economists surveyed by Reuters, only Citi sees a hike to the OCR this month. The consensus is for a quarter point move to 2.75 per cent by the end of March and the same sized moves in the remaining three quarters of 2014.