NZ heading for deflation, leaving central bank hamstrung, BNZ says

Graeme Wheeler will be watching closely for signs of inflation. Photo / NZME.

The New Zealand economy may be in its first six-month period of deflation in more than a decade, in the face of weak crude oil prices and global over-capacity, pushing the prospects of interest rate hikes out into 2016, according to Bank of New Zealand.

Economists at BNZ are forecasting that the consumers price index fell 0.2 per cent in the December quarter and will decline 0.3 per cent in the first three months of 2015, the first two consecutive quarters of deflation since the same period of 1998-1999, when the world was grappling with the Asian financial crisis. However, using the Reserve Bank long-term series for CPI excluding interest rates, New Zealand hasn't seen more than one quarter of deflation since the great depression of the early 1930s.

BNZ head of research Stephen Toplis says for New Zealand, deflation during the current cycle isn't the ugly phenomena being grappled with in, say, the euro-zone, where consumer prices fell 0.2 per cent in 2014 and where demand has been dwindling. By contrast, New Zealand's economy is operating at or above capacity, the housing market is still steaming, and kiwis are showing no inclination to rein in their spending.

"Normally when you talk about deflation you are petrified," Toplis said. "The wheels are falling off, there's a downward price spiral. But there's zero evidence of that in New Zealand at the moment. The single biggest thing is our ability to freely access world goods at low prices. For New Zealanders that's a good thing unless you're a local retailer."

"There is absolutely no evidence whatsoever of retrenchment in activity due to the pressure on the general consumer price level," he said.

Watch video: OCR on hold - Brian Fallow analysis

BNZ's forecasts for deflation are well south of the Reserve Bank's December forecasts, which were for the consumers price index to rise 0.1 per cent in the fourth quarter last year and 0.4 per cent in the current quarter. Wheeler said in last month's monetary policy statement that "modest" inflation pressures suggest economic growth "can be sustained for longer than previously expected with a more gradual increase in interest rates."

With inflation "below target in most of the advanced economies due to spare capacity and declining commodity prices ... monetary policy is expected to remain very supportive for some time," he said.

Brent crude oil has fallen below US$50 a barrel for the first time since 2009 on speculation the Organisation of Petroleum Exporting Countries' decision not to cut production in response to sliding prices will see them drop further, especially with weaker demand in Europe and China, and America's increasing self sufficiency.

Toplis said weak crude oil, global spare capacity and a strong exchange rate have resulted in a "a perfect storm of external shocks". The fall in the price of oil, and therefore fuel, has been a windfall gain for consumers. Added to that there are structural changes including the impact of technology that has seen prices decline for household appliances, cars, telecommunications equipment and computers. internet retailing and relatively efficient freight systems have also resulted in a step down for pricing.

The result for the central bank is for monetary policy to be in stasis. Interest rates are generally low enough so as not to dissuade businesses from borrowing to invest. Inflation expectations are low.

"We're going to have to rethink the way we approach all this," Toplis said. "Small movements in interest rates are going to have very little impact on the economy one way or the other. If the bank raised interest rates tomorrow I doubt it would have any impact apart from on the currency."

At the same time, cutting interest rates would risk stimulating an already heated housing market, he said.

Toplis said globally New Zealand tends to be lumped in with Australia, where low inflation and a sinking economy means cuts to interest rates are already priced in. They'd be mistaken to price in lower rates in New Zealand, he said.