Tobacco tax masks benign inflation outlook - OCR to stay low

Christchurch rebuilding will star putting pressure on NZ inflation stats, but economists think there is little urgency for the Reserve Bank to raise the OCR. Photo / Geoff Sloan

An increase in the government excise on tobacco probably drove up the consumer price index in the first quarter, masking a benign inflation outlook that gives the Reserve Bank little reason to raise interest rates this year.

CPI rose 0.6 per cent in the first three months of 2012, for a year-on-year increase of 1.6 per cent, according to a Reuters survey of 14 economists. The tax on tobacco jumped by 14.5 per cent at the start of the year, making alcohol and tobacco the biggest contributor to inflation in the quarter.

The consensus of economists is marginally below the central bank, which last forecast first-quarter CPI at 0.7 per cent. While there are inflation pressures on the horizon, most notably from capacity pressures in construction as rebuilding starts in Christchurch, expectations for price increases have actually eased.

"The RBNZ has plenty of time on its side to act and there is no urgency to lift rates before the end of 2012," Nick Tuffley, chief economist at ASB, said in a note last week. "The RBNZ has been surprised by how quickly inflation and inflation expectations have fallen recently."

Consumer prices fell 0.3 per cent in the final three months of 2011, surprising economists and the central bank. Companies lowered their inflation view by almost half a percentage point, according to the Reserve Bank's survey of expectations released in February.

Food prices are also expected to provide a positive contribution to inflation though the impact may be more muted than expected after government figures today showed the food price index unexpectedly dropped 1 per cent in March. Prices declined for all five sub-groups measured, the first time that has happened since October 2009.

Gains in school fees and property rents also probably stoked inflation, though the contribution from transport may be milder, with higher petrol prices and lower air fares.

Westpac senior economist Michael Gordon says he will be watching this week's CPI report for signs of the impact of the kiwi dollar's strength on prices of tradeable goods.

The kiwi dollar has mostly held above 81 US cents since late January and even though it has declined from the post-float high reached last August it is still higher than at any time during the past decade.

It was recently at 82.11 US cents and at 73.39 on the trade-weighted index, the central bank's preferred measure. In March the bank forecast the TWI would average 72.5 in the first quarter of 2012. A stronger kiwi typically reduces the price of imported goods.

"Our particular interest in the March quarter figures will be in whether the strong New Zealand dollar is having a prolonged depressing effect on the price of tradeable goods," Westpac's Gordon said in a report. "Any such evidence could shift our view on how long the RBNZ will delay interest rate hikes."

Traders are betting the central bank will raise the official cash rate by just 12 basis points from a record low 2.5 per cent over the next 12 months, based on the Overnight Interest Swap curve. That's about half the increase seen just two weeks ago.

Insurance premiums also probably added to first-quarter inflation, including increases to EQC levies in the wake of Canterbury's devastating earthquakes.