Economists say an uptick in headline inflation due to the weak dollar and rising oil prices shouldn’t discourage the RBNZ from cutting interest rates as core inflation is cooling

Underlying inflation is under control and the Reserve Bank (RBNZ) can continue cutting interest rates despite the short-term risk of higher prices for imported goods and services, economists say.

Consumer Price Index (CPI) data released on Wednesday showed annual inflation was unchanged at 2.2% in the December quarter, marginally above the RBNZ forecast for 2.1%. This was partly due to an increase in petrol prices towards the end of the three-month period.

Despite the slight miss, economists were encouraged by a faster than expected drop in non-tradable (domestic) inflation. Non-tradable prices rose 0.7% in the December quarter, bringing the annual rate from 4.9% to 4.5%.

If domestic prices continue to increase at that rate for four quarters, the annual non-tradable would end up at roughly 3%. This was common prior to the pandemic norm and, when combined with about 1% tradable inflation, could result in the 2% headline rate. 

Tradable inflation has been negative—as in, deflation—for the past four quarters, helping to drag the headline rate into target despite very elevated non-tradable inflation. But that tailwind is likely to be lost, as oil prices climb and the NZ dollar weakens.

There are also other variables which may add inflation pressure in the short term. For example, recent data has been helped by a new childcare subsidy and fresh produce falling from abnormally high levels. Neither will be repeated

Many expected insurance cost increases would slow as reinsurance costs settled, but that may be disrupted by the wildfires in the United States, which are expected to be the most expensive in history. Long story short: there are a few extra inflation pressures in the queue.

Further disinflation will need to come from the non-tradable category to prevent the headline rate from climbing back to 3% again. Luckily, this appears to be happening.

Kiwibank economists said in a note less than half of all items in the CPI basket saw price increases during December and nearly 40% experienced price declines. That has not occurred since 2020 and suggests that disinflation is spreading more broadly, even in sectors less sensitive to interest rates.

All of the various core inflation measures moderated in the quarter. CPI excluding food, fuel and energy dropped 0.1 points to 3%, the weighted median (which singles out the middle price change) was down 0.2 points at 2.5%, and the RBNZ’s two core inflation models eased 0.1 points to 2.3% and 0.2 points to 3.1%, respectively.

Policymakers at the RBNZ don’t rely on any single core inflation measure and generally want to see them all trending in the same direction. They will be pleased to see progress on core inflation, even if the headline rate creeps higher in the next few data releases. 

Miles Workman, a senior economist at ANZ, said if anything the December CPI numbers should add to the central bank’s confidence it has tamed underlying inflation and that monetary policy should return to a neutral setting.

Mark Smith, a senior economist at ASB, said he was increasingly confident domestic pricing pressures were cooling and interest rate cuts could continue. Last November RBNZ Governor Adrian Orr signalled the Official Cash Rate could be lowered another 50 basis points, to 3.75% from 4.25%, when the RBNZ next reviews it in late February. 

Kiwibank economists said that cut was “pretty much a done deal” but there was doubt as to whether the policymakers would keep cutting much after that.  

“The RBNZ is signalling a pause at 3.5%... a long pause... We believe more needs to be done to stimulate the recovery into 2026 and beyond. We believe the inflation problem is no more,” they wrote.