By Bernard Hickey
Inflation was much weaker than expected in the December quarter, sharply increasing expectations the Reserve Bank will have to cut the Official Cash Rate again later this year to drive inflation back up into its target band.
Statistics New Zealand reported the Consumer Price Index fell 0.5% in the December quarter from the September quarter, which was more than 0.2% to 0.3% fall forecast by the Reserve Bank and economists respectively.
Annual inflation was 0.1% in the December quarter, which was also below the Reserve Bank’s forecast in its December quarter Monetary Policy Statement for 0.4% annual inflation.
The New Zealand dollar dropped almost 1 USc to a four month low of 63.7 USc after the result. The two year swap rate, which is the wholesale interest rate that fixed mortgage rates are based on, fell as much as 8 basis points by late afternoon trade. Financial markets increased their measure of the chances of an OCR cut at the March 10 Monetary Policy Statement and decision to 60% from 40%.
It was the fifth consecutive quarter where annual inflation has been below the Reserve Bank’s 1-3% target band and the 17th consecutive quarter where annual inflation has been below the 2% midpoint targeted by the current Governor Graeme Wheeler in his Policy Targets Agreement with Finance Minister Bill English.
The result is expected to increase the pressure on the Reserve Bank to cut interest rates again later this year. The December quarter deflation was the most since the December quarter of 2008. The 0.1% annual inflation was the lowest inflation rate since prices fell 0.5% in the September quarter of 1999.
The New Zealand dollar dropped almost one USc to 64.09 USc after the release of the data on increasing expectations for rate cuts.
Petrol prices fell 7.0% in the quarter from a year ago and vegetable prices fell 17.0%, but there was pressure on prices from housing costs, both of new houses and rents.
Rents rose 2.5% nationally for the year and were up 3.3% in Auckland. The cost of new houses, excluding land, rose 1.2% in the quarter and was up 5.0% for the year, with Auckland house building costs rising 7.2% for the year.
Rates increases of 6.2% were also a factor pushing non-tradable inflation of 1.8% for the year. Tradable prices fell 2.1% for the year.
International airfares also fell 8.1% for the year, while milk, cheese and egg prices fell 8.7% from a year ago.
ASB Chief Economist Nick Tuffley said the result backed his view that the Reserve Bank would have to cut the Official Cash Rate again in June and August.
"The result reinforces our view that inflation pressures won't pick up to the extent the RBNZ is forecasting without further rate cuts," Tuffley said.
"Not only does this support our view for further rate cuts, it suggests an increased risk that cuts could happen earlier than June (our forecast), particular if domestic and offshore economic conditions continue to deteriorate," he said.
ANZ Senior Economist Mark Smith said the 1.8% fall in tradable prices in the quarter dominated the result and was higher than expected.
"There were also few signs the disinflationary impact of past NZ$ strength was abating, with falls for prices for motor vehicles, telecommunications equipment, package holidays, household textiles and appliances," Smith said.
"So far, competitive pressures were proving an effective inflation suppressant, with Statistics NZ reporting that 14% of retail items were discounted in Q4," he said.
ANZ still expected the Reserve Bank to hold the OCR at 2.5%, "but a low inflation backdrop provides the RBNZ with scope to move the OCR lower if the outlook for economic activity deteriorates," he said.
Westpac Chief Economist Dominick Stephens said the result would be a material surprise to the Reserve Bank.
"What really stands out is that we are not seeing pass through from the lower NZ dollar," Stephens said.
"Combined with continued softness in oil prices, it’s looking very unlikely that inflation will return within the RBNZ's target band this year (inflation has already been outside their target band for a year now)," he said.
"This reinforces our expectation that the RBNZ will need to continue cutting the OCR over the coming months. It also increases the risk that cuts happen sooner than we had anticipated. We had penciled in a rate cut in June, but March is now looking very much like a live decision. Pricing for a March OCR cut moved from 40% to 60% after the CPI was released."
BNZ Senior Economist Craig Ebert said the pressure would be on the Reserve Bank when it makes its first OCR decision of the year whether it was a "flexible Fred or a nervous Nellie again."
"Either it redoubles its December MPS talk of flexible inflation targeting, reinforcing a steady policy rate outlook," Ebert said.
"Or the Bank signals that it is once again getting nervous, such that it is opening the door to further OCR easing. It’s come to the crunch," he said.
Ebert said the core inflation was not as soft as the headline, but that the smoke from the data would keep the pressure on the Reserve Bank to ease. He said further rate cuts would not be riskless and he pointed to REINZ figures house price inflation broadening out beyond Auckland.
"Of course, these asset-price versus CPI divergences are happening amid a broader debate (globally) about what rates of inflation central banks can reasonably hope to achieve these days, when an increasingly competitive, and interconnected, world economy, along with technological change, is creating a lot of good deflation," he said.
(Updated with more detail, reaction)