Bernard Hickey: Where is the promised inflation?

Reserve Bank Governor Graeme Wheeler is under increasing scrutiny over inflation policy. Photo / Mark Mitchell

Is New Zealand's low inflation a structural change or just cyclical? The Reserve Bank's lack of certainty is causing exporters and businesses grief.

In its December Quarter Monetary Policy Statement on Thursday, the bank left its Official Cash Rate on hold at 3.5 per cent.

But its insistence on continuing to forecast increases in interest rates surprised and disappointed some.

The bank's decision to keep its "tightening bias" despite annual inflation well below its 2 per cent target showed it still believes strong economic growth will eventually turn into inflation.

There are lots of good reasons beyond the Reserve Bank's control that inflation has been so weak.

The strong New Zealand dollar has helped press down on prices of imported goods and services and our products that compete with the rest of the world.

The Reserve Bank has been as wrong as everyone else in predicting the fall of the currency. But its key task is accurately forecasting "non-tradeable" inflation, which includes taxes and rates, electricity prices, health and education costs, construction costs and bank fees.

The problem is this non-tradeable inflation is surprisingly low, given the economy's growth.

Around the world, there is talk that ageing populations, globalisation of services, massive production capacity in Asia and Europe and new labour-saving technology are affecting non-tradeable inflation in a structural way.

Inflation hawks worry this is temporary and the inflation demons of the 70s, 80s and 2000s will return.

The doves think low inflation, and maybe even deflation, is here to stay and interest rates should be set lower. Long-term interest rate markets have placed their bets on this low inflation being structural. Ten-year bond yields are below 1 per cent in Japan and Germany and below 3 per cent in the US.

The Reserve Bank acknowledged that the uncertainties could mean it was overestimating inflation. That matters because it then tends to run interest rates too tight and drive inflation below its target of about 2 per cent.

Getting it wrong enough for long enough will turn into a sackable offence for Reserve Bank Governor Graeme Wheeler.

The Reserve Bank's forecasts show annual Consumer Price Inflation will have been under 2 per cent for five years until September 2016. The highest it rises to in its forecast track is just 2.1 per cent.

The bank is looking again at its forecasting models.

Wheeler is coming under increasing scrutiny about whether he has run policy too tight.

The New Zealand dollar's US1.4c rise on the morning of the bank's reiteration of its tightening bias emphasised those concerns, particularly in a week when Fonterra slashed its payout forecast by 11 per cent to an eight-year low.

Businesses, unions and exporters are rightly wondering: where is all this inflation the bank keeps warning about? Why is it keeping interest rates so high?

Wheeler will want some more certainty on the answer well before the end of his first five-year term in 2017.