Inflation missing in action despite strong economy

Inflation for the year ended up at 1.6 per cent - short of the 2 per cent mid-point that would cause the RBNZ to consider raising rates. Picture / NZME

If you were hoping for inflation to drive some extra growth in the economy this year then today's Consumer Price Index data did not deliver the numbers you were looking for.

At just 0.1 per cent for the December quarter prices barely moved late last year as vegetables and household goods fell, offsetting petrol hikes.

Inflation for the year ended up at 1.6 per cent - still inside the Reserve Bank's 1 to 3 per cent target but well short of the 2 per cent mid-point that would cause the RBNZ to consider raising rates.

"This release suggests that inflation has yet to stage a convincing comeback in NZ, outside of the housing sector," wrote ASB senior economist Jane Turner. "Raising numerous questions about the strength of inflation moving forward it reinforces that there is no need for the RBNZ to raise interest rates anytime soon."

Westpac's Michael Gordon notes that "virtually every category with imported content came in below our forecasts".

"The most significant declines were in clothing, household contents, and a 6 per cent drop in new car prices."

Paul Dale at Capital Economics notes there is "unseasonable weakness in clothing prices, household goods, car prices and phone contracts".

"Some of this may be due to retailers providing deeper discounts on Black Friday and in the run up to Christmas at the expense of smaller discounts in January. The underlying trend may therefore not be quite this weak," he wrote.

Nevertheless he also sees the weaker inflation as confirmation that the RBNZ will be comfortable keeping rates on hold for all of 2018.

"So while there has been a lot of talk about how the incoming Governor will deal with the new employment mandate, he won't be able to ignore the lack of inflation either. As such, we think the markets are wrong to price in an interest rate hike this year. We don't expect any until the second half of 2019."

That view is a far cry from the optimism of HSBC economist Paul Bloxham who this week picked the RBNZ to raise rates as early as the third quarter of the year and saw annual inflation rising above 2 per cent.

In a his latest New Zealand report Bloxham forecast that New Zealand's ongoing economic growth coupled with increased spending by the new Government and an improving global outlook would put pressure on the RBNZ to raise rates sooner than many expected.

The divergent views are a reminder that the outlook for inflation remains one of the great uncertainties in modern economic forecasting.

Both price and wage inflation have been extremely low throughout the Western world since the global financial crisis.

Some economists speculate that new technology and globalisation have caused structural changes which are suppressing inflation.

Others believe we are in an abnormally long economic cycle, which means central banks need to remain wary of the risk that inflation returns sharply, destabilising markets.

"At this stage, we retain a view that domestic inflation will rise and broaden in time," wrote ANZ senior economist Philip Borkin.

In line with HSBC's Bloxham, he notes that skill shortages and government policy changes will continue to lift wage inflation.

But Borkin also sees rates staying on hold until mid-2019 as other pressures keep inflation subdued.

"Other policies (such as the free first year of tertiary education) will have a mechanical offsetting impact. And together with recent movements in oil and the NZD, the impact of structural deflationary forces, and the fact we see growth over the coming 12 months or so only at trend, and not above, it remains a murky picture."