Inflation toes bank's line

By JIM EAGLES business editor

The Reserve Bank should have been comforted by the further easing in the rate of inflation recorded in the latest consumers price index figure.

As a result it seems highly unlikely that its official cash rate review next Wednesday will see any need to change the present interest rate settings.

The CPI, released yesterday, records a 0.6 per cent increase in the December quarter, bringing annual inflation down to just 1.8 per cent.

That is precisely what the Reserve Bank had forecast and is very much in line with general market expectations.

Although the CPI contains some underlying signs of inflationary pressure - especially in the housing construction area - the latest figures do not point to any immediate threat to the bank's 0 to 3 per cent target range.

The benign inflationary result in the December quarter follows a September quarter, also 0.6 per cent, which brought the annual rate down to 2.4 per cent and within the target range for the first time in a year.

Most economists think inflation will now stay within the range and there is little prospect of the bank continuing its run of five interest rate cuts, which have brought the official rate to its lowest level for two years.

The CPI is expected to have an upward blip in the March quarter, when the big reduction in state housing rentals drops out of the equation, and then to settle back.

But there is considerable debate among economists about whether the impact of a slower global economy will be sufficient to bring the CPI all the way back to the Reserve Bank's preferred area of 1.5 per cent.

Deutsche Bank chief economist Ulf Schoefisch sees cause for concern in several of the underlying economic indicators.

For instance, he says, the fact that 63 per cent of the items on Statistics New Zealand's price list rose during the quarter shows clearly what the trend is.

Furthermore, the weighted median of quarterly price changes - which eliminates the more extreme figures - was 0.7 per cent and the weighted median of annual price changes was 2.5 per cent, which, he says, indicates where the CPI is heading.

As a result Mr Schoefisch believes that unless the international situation deteriorates again there will be no room for further cuts and the bank will "commence its interest rate tightening cycle in August".

A more middle-of-the-road stance is taken by Stephen Toplis, head of market economics at the BNZ, who sees upward pressures in areas such as insurance, food and housing being balanced by lower wage pressures, a reasonable amount of spare capacity, lower commodity prices and a slightly stronger dollar.

That, he says, suggests "the Reserve Bank can afford to sit on its hands for some time".

At the other end of the argument is Adrian Orr, chief economist for WestpacTrust, who believes the risk of inflation is so small that the Reserve Bank could contemplate a further cut of a quarter of a percentage point at its March review.

The impact of the global slowdown on the New Zealand economy is only now starting to be felt, he says.

"Net inward migration is also adding to the labour supply, reducing some of the immediate pressures on the labour market."

As a result "the medium-term pressures on domestic inflation are still downwards", hence the potential for a further rate cut in a couple of months and the prediction that "interest rates are likely to remain at these historic lows throughout the course of 2002".

Those economic arguments are, however, around a broad area of agreement that the New Zealand economy is weathering the international storm fairly well and that there is little cause for alarm on the inflationary front.

Over half the December quarter CPI increase came from rising food prices as a result of high world prices in the preceding months.

The main drivers were increases in the cost of milk - which rose 4.8 per cent on top of a 4.1 per cent rise the previous quarter - and beef. But since then international commodity prices have fallen.

On the other side of the equation, fruit and vegetable prices fell by 3.5 per cent, although they are still higher than a year before and have risen sharply in the past few weeks as a result of the wet weather.

A further quarter of the CPI increase was due to the cost of housing. The most significant contributor was an increase in the cost of building new dwellings because of increases in materials, subcontractors' charges and labour costs.

Construction industry forecasts suggest that trend is likely to continue, raising fears that housing costs will, once again, be the main inflationary threat.



The CPI records that local authority rates rose by 0.9 per cent in the December quarter. That takes the annual increase last year to 3.7 per cent, or double the level of inflation.

There were also increases in health care, tobacco and alcohol, air fares, clothing, recreation, education and household operation.

Those rises were partially offset by the continued fall in petrol prices.