First quarter Consumer Price Index expected to show annual inflation tracking below, or near bottom, of RBNZ's 1% to 3% target band

Economists are expecting Thursday's first quarter Consumer Price Index (CPI) to show annual inflation below, or near, the bottom of the Reserve Bank's 1% to 3% target band.

ASB's economists are expecting March quarter CPI to rise 0.6%, bringing annual inflation to 1.1%. Westpac's economists are picking 0.4% and 0.9% respectively, BNZ's expect 0.5% and 0.9%, and ANZ's forecast 0.3% and 0.8%.

The last CPI data out of Statistics New Zealand, for the December 2012 quarter versus the September 2012 quarter, showed CPI fell 0.2%. And for the 2012 year CPI rose 0.9%, with tradable inflation (covering goods and services whose prices are generally set by world markets), down 1%, and non-tradable inflation (covering goods and services whose prices are largely determined domestically), up 2.5%. See our full December quarter and 2012 year story here.

The Reserve Bank's Policy Targets Agreement with the Government states it must strive to keep future CPI inflation outcomes between 1% and 3% on average over the medium term, with a focus on keeping future average inflation near the 2% target midpoint.

Westpac senior economist Michael Gordon points out Westpac's expectation of annual inflation holding steady at 0.9% for the March quarter was a view shared by the Reserve Bank in its March Monetary Policy Statement (MPS).

"Inflation has slowed by a lot more than expected over the last year and a half, in large part due to the stronger than expected New Zealand dollar – something that will clearly be an issue for upcoming inflation prints as well," Gordon says.

"However, the Reserve Bank’s focus should remain on the medium-term outlook for inflation, where the buoyant housing market and the Christchurch rebuild are starting to generate some home-grown inflation pressures. Our forecast is close to the Reserve Bank’s view and the range of market forecasts, so the implications for markets revolve around the risk of a substantial ‘miss’."

Inflation has come in below the RBNZ's forecasts for 6 straight quarters

Gordon also notes, however, that inflation has fallen short of the Reserve Bank's forecasts in the last six consecutive quarters, largely on the tradables side. He says this raises the possibility the New Zealand dollar is having a stronger than usual effect on local prices.

"We’ve gone through our forecast with a fine-toothed comb to guard against that risk. Nevertheless, another undershoot would seriously strengthen the case for an easier monetary policy stance - definitely later Official Cash Rate (OCR) hikes, and even the possibility of cuts in the near term," Gordon says.

"On the other hand, an upside surprise would see annual inflation back within the Reserve Bank’s 1% to 3% target band - not a concern in itself, but it’s one of the last remaining hurdles to our call for OCR hikes."

"Near-term growth is running stronger than the Reserve Bank expected, the housing market is heating up, and the massive Christchurch rebuild is clearly well under way. All of those factors suggest greater price pressures over the Reserve Bank’s medium-term policy horizon," adds Gordon.

ASB senior economist Jane Turner says ASB's expectation of first quarter CPI increasing 0.6%, bringing annual inflation to 1.1%, is above the Reserve Bank's March MPS forecast of 0.4% quarter-on-quarter.

"Behind the first quarter increase, we expect a lift in non-tradable inflation led by increased taxes on tobacco, increased prescription charges, a lift in food prices and continued growth in construction costs and rents," Turner says. "Providing some offset will be the subdued tradable inflation as a result of the high NZ dollar."

Turner adds that ASB is assuming some unwinding of strong discounting in the December quarter, and if this doesn't materialise, there's downside risk to ASB's forecast.

"To date there has been limited spillover of the higher construction costs from rebuilding in Canterbury, which we assume will continue. But potential for construction costs spillover, as well as supply shortages in Canterbury and Auckland, present some upside risk to housing-related components," says Turner.

'When in doubt, do nowt'

Turner suggests the Reserve Bank may choose to "look through" an increase in first quarter non-tradable inflation, given higher taxes and charges are key contributions to the increase.

"However, with the economic recovery broadening we expect generalised inflation pressures will begin to lift from the second half of 2013. We continue to expect the Reserve Bank to lift the OCR in March 2014," Turner says.

Meanwhile, ANZ's economists say with the "resilient" Auckland housing market putting OCR cuts on the back burner, market reaction to a low CPI outcome is likely to be limited.

"It would take evidence of a sustained lift in the trajectory for core inflation to shake the Reserve Bank view of no OCR hikes over 2013. We are not expecting this on Wednesday and expect the inflation picture to be consistent with a 'when in doubt, do nowt', view of monetary policy," ANZ's economists say.

(Update adds ANZ comments).