Weak oil, food prices make RBNZ's forecast for rebounding inflation a stretch target

Crude oil prices have dropped by about a fifth since the Reserve Bank's monetary policy statement in December and figures today show weaker food prices, casting doubt on the bank's projection for a rebound in inflation in the first quarter.

Food prices fell 2.2% in the fourth quarter, while the annual decline of 1.3% was the biggest drop since July 2012.

Brent crude sank below $US30 a barrel this week for the first time in almost 14 years. Crude has tumbled 21%, driving down petrol prices, since last month's monetary policy statement (MPS), when the bank said consumer price index (CPI) inflation for New Zealand's trading partners "is expected to pick up sharply over the next year as the decline in oil prices drops out of the annual calculation."

Fourth-quarter consumers price index figures, due for release in four days, are expected to show annual inflation was just 0.4% in 2015, based on the both the Reserve Bank and economist forecasts.

The central bank sees annual inflation tripling to 1.2% in the first quarter and returning to the mid-point of its 1-3% target band next year.

A weaker track for inflation increases the prospects of a further cut to the official cash rate, now back at its record low level of 2.5 %.

"The recent weakness in petrol prices will delay the lift in CPI back over 1% until the second half of 2016," says ASB Bank chief economist Nick Tuffley.

"Consequently, inflation is likely to remain below the RBNZ's target band for about two years. We expect persistently weak inflation pressures will prompt two further 25 basis point OCR cuts from mid-2016."

ASB Bank cut its forecast for fourth-quarter CPI to -0.3% from a previous -0.2% rate after figures today show food prices fell more than expected. It kept its forecast for annual inflation at 0.3%.

The trade weighted index (TWI) was recently at 71.51 and will need to fall over the next three months to bring the first quarter average down to the 69.4 level the Reserve Bank projected last month.

A stronger currency reduces the cost of imported goods and part of the Reserve Bank's assumption for a rebound in inflation is the kiwi dollar falls and import prices rise.

The TWI has fallen from a six-month high 74.57 reached at the end of 2015, although the impact on consumer prices may depend on the ability of retailers to pass on any increases in the cost of imported stock.

ASB forecasts a 1% drop in tradable inflation for the fourth quarter, and an annual decline of 1.4%. Both would mark a weakening compared to the third quarter and a greater decline than the central bank is expecting. Non-tradable inflation probably rose 0.3% in the quarter and 1.5% in the year.

Westpac Banking Corp is also likely to dial back its inflation forecast following the weak food price data and is predicting a further cut to the OCR to 2.25% in June.

"The Reserve Bank is almost counting on a return to above 1% annual inflation in the March quarter," Westpac's chief economist Dominick Stephens says. "It's not even going to be close."

"There has been more or less a constant rate of decline in crude oil and we'll see the same impact in the year to March," he says.

So far this year there has been a rout in global sharemarkets and renewed concerns about China's economy. A further cut in Fonterra's milk payout is on the cards and some of the steam is coming out of the Auckland housing market.

Mr Stephens says the market had latched on to Reserve Bank governor Graeme Wheeler's comments in the December MPS that the central bank expected to be able to return average inflation to the midpoint of its target range "at current interest rate settings" and had overlooked his next thought, that the bank "will reduce rates if circumstances warrant."

(BusinessDesk)