Two-year inflation remains at 2.6pc

Expectations of inflation two years out remain unchanged at 2.6 per cent in the Reserve Bank's latest quarterly survey.

Economists expect the bank to take comfort from the figure, as one of its key assumptions has been that the impending spike in the annual inflation rate from GST and other government charges will not flow through to higher inflation expectations over the medium term.

"While two-year-ahead inflation expectations, at 2.6 per cent, are in the upper half of the Reserve Bank's target band, they have not shown any meaningful increase in response to the pending spike in inflation," Goldman Sachs economist Philip Borkin said.

"If anything, inflation expectations have fallen from the recent peak of 2.8 per cent in the June 2010 survey. While still early days, this will be welcomed by the bank and should allow it to remain on the sidelines until firmer evidence is present that the economy is building momentum."

Between 2000 and 2008 inflation expectations on a two-year horizon trended upward from 2 per cent, hitting 3 per cent by December 2008. Since then they have been more volatile, but have remained in the upper half of the bank's 1 to 3 per cent target band.

"Turning to quarterly CPI expectations, a rise of 3.45 per cent is expected for the December 2010 quarter with GST and other tax changes being factored into respondents' expectations," the Reserve Bank said.

"For March 2011 expected quarterly inflation falls dramatically, to 0.63 per cent. These quarterly increases are equivalent to annual inflation rates of 5.2 and 5.4 per cent respectively for the years to December 2010 and March 2011."

Both are well above the bank's own forecasts of 3.8 and 4.1 per cent respectively, before inflation peaks at 4.8 per cent next June.

But ASB economist Christina Leung regards the inflation forecasts as too low and expects it to become less comfortable with the inflation picture over the coming year.