Bank raises spectre of $2 a litre petrol

Motorists already changing their spending habits to accommodate higher petrol prices are being warned that $2 a litre petrol could be on the way next year.

ANZ bank said that in the shorter term a further increase of 5c to 7c a litre could take the price at the pump to $1.77 a litre.

The estimate came after geopolitical tensions last week sent oil prices to all-time highs and was based on the New Zealand dollar being below US61c. This week so far it has been just above that level.

The figure of $1.90 to $2 a litre next year was based on oil prices remaining around US$70 ($116.14) a barrel, and the NZ dollar falling to between US50c and US55c.

Assuming a price of $1.77 a litre, headline inflation would be set to hit 4.2 per cent in the March 2007 quarter, well outside the Reserve Bank's 1 to 3 per cent target range, ANZ said.

During the next 12 months petrol was likely to add around 0.9 percentage points to inflation.

"A key implication from this is that in order to get the headline inflation rate down below the 1 to 3 per cent policy band, a sharp easing in non-petrol inflation pressure is required."

The prospects of higher headline inflation would be giving the Reserve Bank "palpitations", ANZ said.

But the Reserve Bank's focus should be on non-tradable inflation, which ANZ doubted would stay elevated for long in an environment of slowing growth.

Ultimately the negative growth consequences of higher oil prices would counter the inflationary impetus on medium-term inflation pressure, ANZ predicted.

High petrol prices would undoubtedly slow growth, and exacerbate the domestic demand slow-down and the long-awaited period of consumer consolidation.

But the weaker NZ currency behind the second leg of the petrol price-induced spike would be positive for growth.

Despite that, ANZ forecast a protracted period of subdued growth in the coming two years.

Momentum was expected to recover from 2008 on the back of an export-led recovery, but rejuvenation of the household sector was not expected until 2009.

ANZ predicted the Reserve Bank would start aggressively reducing official interest rates from next March.

Less alarming predictions for the petrol price than those from the ANZ have been made by Westpac, which is forecasting prices holding around $1.70 a litre to the end of 2006 before falling.

But Westpac acknowledged the outlook for oil was a key source of uncertainty for the inflation outlook.

During 2006 the direct inflationary impact of petrol prices alone would be around 0.7 percentage points, with airfare increases and wider impacts on transportation costs adding even more, Westpac said.

"In other words, oil prices make the difference between inflation being within the 1 per cent to 3 per cent RBNZ target band, or above."

Even with the economy heading for significantly slower growth, the Reserve Bank was preoccupied with the risk that a sustained period of high inflation would shift perceptions of inflation.

"Consumers, seeing higher prices for goods (particularly petrol), may start being more aggressive in demanding higher wages in compensation," Westpac said.

"Businesses, taking note of rising cost pressures, might be more inclined to try and recoup these costs. And collectively, we may all become more accepting of these demands, ensuring that inflation remains elevated or is very slow to come back to an acceptable level."

In the past inflation expectations had quickly stabilised once actual inflation declined, Westpac said.

"But, for the RBNZ, past experience also shows it takes a lot of effort (aka higher interest rates) to rein them back in if expectations do gallop away."

- NZPA