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Static inflation holds off interest rate rises

Monday 18th January 2010

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New Zealand inflation was probably unchanged in the fourth quarter, reflecting a drop in food prices, which may help convince the Reserve Bank to hold off on raising interest rates until April.

The Consumer Price Index held steady from the third quarter, when prices jumped a higher-than-expected 1.3%, according to the median estimate in a Reuters survey of 13 economists. Forecasts ranged from -0.3% to +0.3%. The inflation rate may have gained 2.1% from the same quarter of 2008, within the RBNZ’s 1% to 3% target range. The data is released on Jan. 20.

Fourth-quarter CPI will be a key indicator for Reserve Bank Governor Alan Bollard, who last month predicted a decline of 0.2% while flagging concern that the recession hadn’t dented inflation as much as expected. Bollard has tipped a mid-year increase in the official cash rate from its current record low 2.5% but the market is anticipating he will start as soon as March and have hiked the OCR by 75 basis points by June 30.

“Annual inflation will look well behaved over 2010, influenced by the lingering impacts of recession as well as a reversal of food price increases,” said Nick Tuffley, chief economist at ASB.

Still, “the tide of underlying inflation pressures will begin turning as the economy continues to gradually recover” and Bollard “will need to start reducing monetary stimulus relatively soon,” he said last week. Tuffley expects a 50 basis point hike in April.

Seven of 18 economists surveyed by Reuters predict a 25 basis point increase in the OCR in March, with the rate climbing to 3.75% by the end of September. If the RBNZ fails to lift rates in March, that implies an increase at each of the four ensuing OCR reviews through September with one of 50 basis points.

Food, the biggest contributor to the CPI, may have fallen 2.2% last quarter, taken away 0.38 points from inflation in the final three months of 2009, according to Deutsche Bank. Prices of food climbed in the third quarter, spurred by bad weather that cut production of fruit and vegetables.

Bollard hardened his language in the December Monetary Policy Statement, bringing forward the likely timing of tighter monetary conditions amid signs of continued recovery in the domestic economy. He expects non-tradables inflation was 0.3% in the fourth quarter.

Bollard singled out the impact on consumer spending of higher house prices as “a key uncertainty,” noting that credit growth so far has remained subdued.

Domestic property values climbed 2.8% in 2009, according to a QV Valuations report last week, edging back toward their late 2007 peak. Real Estate Institute house price data for December is due out today, after prices held at a 10-year high in the previous month.

“We expect Q4 to be the low-point for quarterly inflation,” said Brendan O’Donovan, chief economist at Westpac Banking Corp. “Over 2010 we expect housing-related prices to begin rising again as the construction sector’s recovery gets underway.”

O’Donovan predicts Bollard will begin hiking rates in March though is fourth-quarter CPI is weaker than the RBNZ’s -0.2% forecast, “then the central bank will feel even more comfortable waiting and our call for a March hike will look unrealistic.”

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