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Inflation edges closer to Reserve Bank's mid-point as economy soaks up capacity

New Zealand business confidence fell from a 20-year high in the second quarter, based on the Quarterly Survey of Business Opinion, but most economists focussed on signs in the survey that inflation is accelerating.

The consumer price index rose 0.4 percent in the second quarter for an annual pace of 1.8 percent, according to a Reuters survey. The government figures due for release on Wednesday would mark the fastest inflation since the third quarter of 2011, when prices reflected the 2010 hike in good and services tax to 15 percent.

Market consensus for CPI is just ahead of the Reserve Bank on 0.3 percent for the quarter and 1.7 percent annual. The data comes after the QSBO last week showed a net 90.6 percent of respondents expected to increase capacity utilisation, above the long-run average for at least the fifth straight quarter. A net 33 percent of firms surveyed expect to lift prices in the next three months, the second quarter in a row where expectations were above the long-run average.

The net number of firms that saw capacity as a constraint rose to 15.1 percent last quarter, almost twice the long-run average.

As the QSBO showed, "a growing number of firms are saying that they not only intend to raise their prices, but are successfully doing so," Michael Gordon, senior economist at Westpac Banking Corp, said in his CPI preview.

If expectations are met, the Reserve Bank will have no reason not to raise the official cash rate a quarter point to 3.5 percent on July 24, the highest level since December 2008.

Gordon sees food and electricity prices leading the gains in second-quarter inflation. Food prices rose in each month of the second quarter, while in the electricity industry, grid and network costs are being passed on to consumers and businesses.

Tradable inflation is likely to remain low over the coming year, given the strength of the kiwi dollar, which is set to test its post-float high of 88.42 US cents this week. Economists at ASB say the damping effect of overall inflation from weak tradable inflation "is likely to lessen over 2015 and 2016" as the kiwi dollar falls and retailers fatten their margins.

"There are signs underlying inflation pressures will continue to lift over the coming year," the economists said in a note. "We expect the annual rate of non-tradable inflation will edge up towards 3.7 percent by late 2015 as the NZ economy gains further momentum."

(BusinessDesk)