Expectation inflation still in 1%-3% target range

Inflation is expected to have remained in the middle of the Reserve Bank's 1%-3% target range in December and figures out tomorrow should not cause the Reserve Bank to change its plans for rate hikes.

The Reserve Bank is expected to make its first change to the official cash rate (OCR) in March, possibly April, although it does have an opportunity later this month to lift the rate from the current 2.5%.

While inflation for the three months ended December was expected to have fallen slightly, annual inflation was expected to have reached 1.5%.

ASB economist Christina Leung said weaker tradeable inflation was a key feature of the subdued outcome expected from December. She expected tradeable inflation to have fallen 0.8% in the quarter.

That largely reflected the seasonal fall in fruit and vegetable prices.

Added to that was the modest fall in petrol and diesel prices over the quarter, which ASB estimated provided a negative contribution of 0.2% to the consumer price index (CPI) - the official measure of inflation.

The continued strength of the New Zealand dollar had placed downward pressure on the price of imported goods over the past year, she said.

The Reserve Bank highlighted the dampening influence of the high New Zealand dollar on tradeable inflation.

However, tradeable inflation had been lower than movements in the dollar would suggest, largely reflecting modest household demand, Statistics New Zealand having reported widespread discounting of imported household items.

''This reflects the increasingly competitive retail environment, with retailers' margins crunching in over the past few years as a result.''

More recently, household demand had improved, reflecting increasing consumer confidence in light of a stronger labour market and higher house prices.

Market speculation of an OCR increase at the January meeting had increased in recent weeks, the December CPI being seen as a ''game changer'', Ms Leung said.

The Reserve Bank's December forecast of a 0.2% fall in the CPI would still leave annual inflation at 1.4%, still in the bottom half of the target range.

It was extremely rare for the CPI to surprise by more than 0.5%. Since March 2004, there had been only two quarterly CPI results which had been 0.5% or more off forecast in either direction, while two others had surprised by 0.3% to 0.5%.

Ninety percent of quarterly results had differed less than 0.3% from market expectations.

''In fact, markets have had a tendency to overestimate the CPI, particularly over the past two years,'' Ms Leung said.

ASB saw the risks to its inflation forecast as fairly balanced, she said.


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