Influential RBNZ survey shows substantial drop in expectations of inflation in two years time - albeit that at 3.3% the survey respondents still see inflation outside the targeted band in 2025

A survey the Reserve Bank pays close attention to has shown a fairly substantial drop in the expected level of inflation in two years time - a drop possibly sufficient to encourage the RBNZ to make a smaller hike to the Official Cash Rate than it had intended next week.

The results of the latest Survey of Expectations, carried out quarterly for the RBNZ, will carry weight with the central bank in making its next decision on the Official Cash Rate on February 22.

At the moment the OCR is at 4.25%. Earlier the expectation had been that next week the RBNZ would hike to 5%. But these survey results coming on top of some weaker than expected economic data releases recently, might be enough to convince the central bank to 'just' raise the OCR to 4.75%.

The key result in the survey is that the expectation for inflation in two years' time - the most watched measure in the survey - has dropped to 3.3% from 3.62% three month ago.

After the two-year expectation spiked hugely in the previous survey this latest result will be heartening for the RBNZ in its battle to get inflation back into the 1% to 3% range.

But of course, heartening as the result may be, it means expectations are that the inflation rate will still be outside of the target range in early 2025 - while the RBNZ itself is forecasting it will get inflation back under 3% by September 2024.

Looking further forward the survey shows the expectation in five years time is that inflation will be on 2.36%. That's down also, from 2.44% in the last survey.

In terms of 10 years out, the expectation has risen slightly from 2.18% to 2.19% - but since that's quite 'well anchored' toward the midpoint of the RBNZ's targeted range it won't be any cause for concern. It's the two-year expectation that is watched closely.

Westpac senior economist Satish Ranchhod said the RBNZ "will likely have breathed a sigh of relief" and the survey release will "help to calm the RBNZ’s nerves about the upside risks for inflation".

"We’re still left with a very strong outlook for inflation over the coming year. However, inflation pressures are looking less alarming than they did back in November when the RBNZ delivered a jumbo-sized 75bp hike in the OCR and signalled that there was more to come.

"Consequently, it looks like the extent of OCR increases required to rein in inflation doesn’t need to be as large as the central bank previously anticipated. We continue to expect a 50bp rise at next week’s RBNZ policy meeting," Ranchhod said.

The data for the latest RBNZ survey was obtained from 39 business leaders and professional forecasters by the Nielsen group on behalf of RBNZ. Field work for the survey was run between January 26 and February 1, 2023.

As stated above, the key survey statistic is what the surveyed experts view inflation will be in two years' time. The RBNZ is always looking for expectations to be 'anchored' around 2%. Recently as actual inflation has taken off these expectations have become seriously unmoored and have risen rapidly.

But since the last survey results came out in early November there's been key December quarter data released including inflation figures and labour market figures that were more benign - from a future inflation perspective - than anticipated. This broke a recent pattern of economic data releases constantly coming in much hotter than forecasts.

The key thing about this survey, particularly in relation to the inflation expectations, is not whether the expectations will prove to be 'right' or not in future. I'm prepared to wager now that they won't. It's all about gauging what the current expectations are - because if people expect higher inflation in future this will actually drive prices and wages higher. It is self-perpetuating.

That's why killing inflation expectations is a key part of the RBNZ's inflation fighting job.

The RBNZ will see the latest survey as a step in the right direction - but with much more to do.

Separately, the survey also included the views of respondents on where they see the REINZ House Price Index in one years' time and two years out. In short the view about the next year is more pessimistic than in the last survey, but the view for two years time is a little brighter.

The RBNZ said one-year-ahead expectations for house price changes were "widely varied".

Compared with last quarter, house price expectations for one-year ahead had a mean of -6.27%, down 88 basis points from -5.39%.

"It is the lowest recorded expectation of one-year-ahead house prices since this question was introduced [into the survey] in September 2017," the RBNZ said.

However, the mean two-year-ahead house price change was higher at 2.35%, "which is 12 basis-points higher than last quarter’s mean estimate of a 2.22% increase", the RBNZ said.