Inflation expectations show sharp fall

Inflation expectations have dropped sharply in the Reserve Bank's quarterly survey of the business sector.

Expectations for inflation two years ahead have dropped to 2.5 per cent, from 2.82 per cent in the previous survey, the steepest fall since the depths of the recession in March 2009.

Historically there is a close match between two-year inflation expectations and business pricing intentions, as reflected in the National Bank's monthly business outlook survey.

The inflation out-turn in December, when the consumers price index fell, was much weaker than forecasters, including those at the Reserve Bank, had expected.

"This may have prompted many to reassess the underlying inflation pressures within the economy," ASB economist Jane Turner said. "Nonetheless, the extent of the decline in expectations is slightly surprising, given in two years we would expect rebuilding activity in Canterbury to be driving a pick-up in construction prices and we see inflation rising back towards the higher end of the Reserve Bank's [1 to 3 per cent] target band."

The Reserve Bank survey also recorded a fall in average expectations of inflation one year ahead to 2.24 per cent from 2.71 per cent in the December quarter survey.

The bank's forecast for the inflation rate two years out is 2 per cent.

The current rate is 1.8 per cent but it was at a credibility-straining 5.3 per cent as recently as June last year, of which only 2 percentage points could be attributed to the October 2010 increase in the GST rate.

Respondents' expectations of wage inflation have also eased, from 2.7 per cent to 2.4 per cent one year ahead, and from 3 to 2.8 per cent the next.

"We still expect inflation to be on the rise in two years' time, underpinned by reconstruction activity," Turner said.

"However, the Reserve Bank has plenty of breathing space around this future pick-up in inflation, as the survey suggests that wage- and price-setting behaviour remains well contained for now and the bank can be less concerned about the potential spillover into more generalised inflation pressures."

A separate survey, of households, recorded a drop in the median inflation expectations one year ahead to 3 per cent from 4 per cent in the previous quarterly poll.

The higher expectations may reflect the fact that the median expectation of the current inflation rate was also 3 per cent, when in fact it is 1.8 per cent, according to Statistics New Zealand.

They also expect house prices to be 3.1 per cent higher in a year's time, up from 2.5 per cent.