Bernard Hickey: Inflation to hit 5 per cent ?

Inflation could hit 5 per cent by the end of the year, well outside the Reserve Bank's target range of 1-3 per cent, but it has decided to remain sitting on its hands.

That's fair enough, given many of these increases are 'one offs', but it's clear now that savings will be eroded and some people will be made poorer by inflation - an issue most people haven't worried about for a long time.

The Reserve Bank's March quarter Monetary Policy Statement has done an excellent job of forecasting the outlook for prices and the economy.

It shows the Emissions Trading Scheme (ETS) is likely to increase prices by around 0.4 per cent and new big ACC levies are likely to increase prices by 0.2 per cent.

At the same time the New Zealand dollar's fall in recent months and an increase in export prices and petrol are driving prices higher. The expected increase in the GST rate to 15 per cent to 12.5 per cent will be the coup de grace for the inflationary outlook.

Added to the current 'natural inflation of just over 2 per cent, it's quite likely the headline inflation rate will be over 5 per cent by the end of 2010.

How do New Zealand consumers feel about that? How will it change their expectations about future inflation? The Reserve Bank will be watching that closely, but it's likely to use its 'get out of jail' cards in the Policy Targets Agreement so that it can 'look through' these one-off increases.

Inflation is a quietly rapacious beast. It erodes the value of savings and changes the way households behave. They're much keener to spend than to save, and more importantly, are much keener to borrow than to save.

This has been the legacy of two decades of high inflation in the 1970s and 1980s. It eventually bloomed in the property boom of the 2000s when savers decided property was the ultimate hedge against inflation.

The government is about to boost inflation a little and hope to get away with it. It may well do in an era of what is likely to be low inflation globally. But if there is another financial crisis or a commodity price boom we risk embedding these inflationary expectations all over again.

It's something the government should think about before it whacks up GST.