2-year ahead inflation expectations jumped in the June quarter, according to the RBNZ

Annual inflation is expected to be 3% in two year's time, matching the highest expected rate since 1991, which was also recorded in 2008, according to the latest Reserve Bank of New Zealand inflation expectations survey.

The quarterly survey showed expected two-year out annual inflation rose from 2.6% last quarter. The 0.4 percentage point rise is the biggest quarterly rise since the September quarter in 1990, figures show.

Expectations for one-year out annual inflation also rose over the quarter, from 2.9% in March to 3.1% this quarter.

The Reserve Bank is expected to keep the Official Cash Rate on hold  at 2.5% until at least December this year, with some economists picking hikes to be held off until the first or even second quarter next year. The central bank is tasked with keeping inflation in a 1-3% target band over the medium term.

Discomfort for RBNZ

ASB economist Christina Leung said the spike in two-year ahead inflation expectations should cause the Reserve Bank some discomfort.

"This is a reasonably strong increase given the 2-year ahead measure tends to be a relatively stable series," Leung said.

"The strong result likely reflects expectations amongst businesses that post-earthquake rebuilding activity over 2012 will boost medium-term inflation pressures. Over the past year, a raft of Government charges has boosted the annual increase in headline CPI to 4.5% and there are signs some of this is beginning to flow through to medium-term inflation expectations," she said.

"The reasonably strong increase in 2-year ahead inflation expectations should start to cause the RBNZ some discomfort, given it has noted it will be vigilant for signs that rebuilding activity will underpin inflation pressures over the medium term.

"Inflation indicators up till now had suggested the RBNZ had plenty of breathing space on the inflation front, but today’s result suggest that space may be ebbing away given the vast amount of post-earthquake rebuilding activity that will be required."

Pricing intentions and cost expectations in business surveys over the coming months would be key in assessing whether businesses were already starting to factor the likely boost to inflation into their business decisions, and thus the effect on medium-term inflation pressures, Leung said.

"Nevertheless, we continue to expect the RBNZ will remain on hold until March 2012.  The timing of earthquake reconstruction will be a key OCR influence.  We expect the construction pick-up will be less rapid than the RBNZ’s March MPS estimate, keeping the RBNZ on the sidelines for a while," she said.

(Updates with ASB comment, chart)