Weak inflation builds case for rate cut next month

Domestic airfares fell 9.9 per cent in the last quarter, said Statistics NZ. Photo / Mark Mitchell

A slower-than-expected pace of inflation has added to the case for an interest rate cut next month as a strong New Zealand dollar continues to keep a lid on imported prices.

Government data today showed the consumers price index rose 0.4 per cent in the June quarter from a year earlier, missing the Reserve Bank's estimate of 0.6 per cent inflation and tracking below the bank's target band for annual inflation of 1-to-3 per cent for the seventh straight quarter.

New Zealand consumer prices rose less than expected in the June quarter as cheaper meat and domestic airfares offset a recovery in petrol prices, adding pressure on the Reserve Bank ahead of its unscheduled economic update.

Tradables inflation, which includes goods and services that compete with imported rivals, fell 1.5 per cent from a year earlier as a strong kiwi dollar continued to make overseas purchases cheaper. Non-tradables inflation, which measures domestic price increases, rose 1.8 per cent from a year earlier.

Traders are pricing in a 74 per cent chance the Reserve Bank will cut the official cash rate a quarter-point to 2 per cent on August 11 when it will next review policy, and the bank's unscheduled economic update this Thursday will be keenly watched for words to that effect.

Economists at ANZ Bank New Zealand, ASB Bank, Westpac Banking Corp and Capital Economics said the CPI data added to the case for lower rates next month, as did currency traders at HiFX.

"We still believe that in a backdrop of a strong domestic economy, growing capacity pressures and broadening housing and credit largesse, cutting the OCR again is not without risks," ANZ senior economist Philip Borkin said in a note.

"However, given low headline inflation, already soft inflation expectations and the strong NZD, it does look like the RBNZ will be dragged back to the easing table once again."

The kiwi dollar trade-weighted index dropped to 75.52 from 76.31 immediately before the release, while two-year swap rates fell about 6 basis points to 2.12 per cent.

The Reserve Bank will get a chance to share its view of the market on Thursday when it provides an "economic assessment".

The bank said it would make out-of-turn statement last week because of the gap between the June and August monetary policy statements under its new timetable, and investors took it as a sign the bank wasn't happy with the strength of the currency and may try to jawbone the kiwi or indicate a rate cut was coming.

The difficulty for the Reserve Bank is the impact lower interest rates have had on the housing market with prices surging due to a shortage of supply in Auckland city and increasing demand, fuelled by record net migration.

We still believe that in a backdrop of a strong domestic economy, growing capacity pressures and broadening housing and credit largesse, cutting the OCR again is not without risks.

Wheeler has had to weigh up the threat posed to financial stability by housing against the deflationary effect of a strong currency, and has the bank has indicated more macro-prudential tools will probably be introduced before the end of the year to try and cool the property market.

Today's inflation data showed new housing was the major driver of rising prices on an annual basis, up 5.6 per cent from a year earlier, while rental prices increased 3.3 per cent.

Property maintenance prices rose 2.9 percent and local body rates increased 6.2 per cent. Electricity prices rose 2 per cent from June 2015.

That also spilled over into housing-related items, with furniture and furnishing prices rising 4.9 per cent from a year earlier, and carpets and other floor coverings up 4.9 per cent, while major household appliance prices increased 0.9 per cent. Real estate services climbed 10 per cent from a year earlier.

Capital Economics chief Australia and New Zealand economist Paul Dale said the Reserve Bank was in a tricky position with inflation weaker than expected and housing stronger.

He still expects the bank will cut the OCR in August and again later this year, and speculated that the Thursday update will see the RBNZ "hint that it's going to use lending restrictions to take the heat out of housing but continue to use lower interest rates to boost inflation."