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16 Jan 2015

Inflation to Stay Low in 2015

Inflation is expected to stay low in New Zealand throughout 2015, with some economists even predicting deflation sometime in the next few years.  While the Reserve Bank is predicting inflation figures of 1 to 3 percent for much of the year, both ASB and BNZ are forecasting inflation below 1 percent.  While falling prices might seem like an attractive proposition for many people, low inflation figures can be a warning of an economy out of balance.

The New Zealand economy is performing well at the moment, with growth at a healthy 3 percent a year and a dropping unemployment rate.  Despite these conditions, however, the inflation index is expected to be flat over the December quarter, making for a small 0.9 percent rise over the last 12 months.  According to BNZ, if oil prices remain weak and global overcapacity remains, inflation will continue to ease and a six-month deflation period is possible.

"New Zealand's situation is particularly enlightening. We have an economy that is operating at or above potential and is set to stay that way for some time. Yet CPI inflation is absent, partly because of the strength in the currency and partly because of falling oil prices, but, more generally, because it’s the global output gap that is the source (or lack thereof) of inflation in the domestic economy. This goes a long way to explaining why, even as domestic capacity pressures intensify later in the year, we still see annual inflation staying below 1.0% until early 2016.” said BNZ.

ASB are also expecting inflation rates to come in lower than Reserve Bank predictions, due mostly to a drop in oil prices over the last quarter.  New Zealand petrol prices have fallen from over $2.20 per litre at the beginning of October to under $1.80 in January, illustrating just how much oil prices have dropped in recent months.  However, with no proof of pressure on the general consumer price level and the consumer price index forecast to increase by 0.1 percent in the December quarter and 0.4 percent in the first quarter of 2015, most experts agree there is nothing to worry about.

According to ASB, "The key development over the December quarter has been the sharp drop in global crude oil prices, which has driven the price of petrol lower...  We estimate the decline in fuel prices means a 0.3 percentage point reduction in the CPI for Q4, with a bigger reduction in store for Q1...  We now expect headline inflation will remain below the RBNZ's inflation target band of 1-3 per cent over much of 2015."

Low inflation forecasts raise serious questions about interest rates, with BNZ coming out in support of interest rate cuts:  “With annual inflation set to stay at or below the bottom end of the RBNZ’s target band for around 18 months and with there being the possibility of measured annual deflation during this period, shouldn’t the RBNZ be cutting interest rates?..  It is going to be very difficult for the RBNZ to raise rates until such time that it actually sees measured inflation rising to threaten the midpoint of its band. And that won’t happen until mid-2016.”  ASB expect the Reserve Bank to hold the official cash rate at 3.5 percent for most of the year.