Inflation in New Zealand is far too low and the Reserve Bank will need to cut the official rate to 2% this year to try to generate some economic activity, Craigs Investment Partners broker Peter McIntyre says.
Statistics New Zealand figures released yesterday revealed headline Consumer Price Index inflation - the official measure - fell to -0.5% in December when the market expected a fall to -0.2%.
Annual inflation fell to 0.1% from 0.4% in September, making it the lowest inflation rate since September 1999.
Mr McIntyre said low inflation was a sign of a lack of demand in the economy and prices were falling instead of going up.
Fuel prices were a large component of the current low inflation environment as products had to be shipped or transported to various markets.
‘‘Low controlled inflation is a good thing but when you cannot control it, like now, it becomes a problem.
Low inflation with matching wage increases is controllable.''The Reserve Bank had a mandate to keep inflation between 1% and 3% with the midpoint of 2% the ideal, he said.
The central bank would have to cut its official cash rate further to try to boost demand and drive inflation to the midpoint of the band.
‘‘The Reserve Bank will cut to 2% to keep inflation in the band and then it find itself between a rock and a hard place. It will be reluctant to go any lower.''
Apart from cutting interest rates, the Reserve Bank only had blunt tools to use to control the economy, Mr McIntyre said.
Negative inflation, where the price of goods fell when supply was higher than demand, would not be good for the economy. The New Zealand dollar dropped in value again yesterday, a concern for importers but a bonus for exporters who could produce more goods at lower costs, he said.
HSBC Australia and New Zealand chief economist Paul Bloxham said the December inflation numbers illustrated how much the Reserve Bank's inflation target was at the mercy of global factors, largely beyond the central bank's control.
There was a sharp fall in tradeable inflation as petrol prices plunged by 7% in the quarter and food prices fell by more than the usual seasonal dip.
Lower global oil prices had been the main drag on inflation during the past year, he said.
In the December quarter, the dollar was, on average, slightly stronger than in the previous quarter, when the Reserve Bank had hoped a falling currency would generate some imported inflation.
Although offshore factors had been key, domestically generated (non-tradeable) inflation also remained ‘‘fairly weak'', Mr Bloxham said.
Housing market pressures in Auckland continued to generate inflation in rents and construction costs. For overall inflation to average 2% over the medium-term, much stronger non-tradeable inflation would be needed.
That was especially true now the hoped-for surge in tradeable inflation was under threat from a stubborn dollar and further falls in global oil prices.
A material increase in domestic price pressure looked unlikely in an economy still exhibiting a degree of spare capacity, he said. In particular, the unemployment rate was elevated and the labour market seemed to be loosening further.
‘‘Lower interest rates will probably be needed and we expect the Reserve Bank to cut by a further 0.25% around the middle of the year. The risk is that they will need to cut more than once,'' Mr Bloxham said.
ASB senior economist Jane Turner expected official cash rate cuts in June and August but saw an increased risk the cuts could happen earlier than June, particularly if domestic and offshore economic conditions continued to deteriorate.
She would be paying close attention to the Reserve Bank's response to the weak inflation result and offshore volatility at next week's OCR review.
