RBNZ inflation expectations survey shows businesses now expect inflation to be below 3% both 1 and 2 years from now

Inflation expectations have fallen, according to the Reserve Bank's latest quarterly survey of business managers, with respondents now expecting inflation to be below 3%, the top end of the central bank's target range, in both one and two years' time.

The Reserve Bank is tasked with keeping inflation between 1% and 3% on average over the medium term. In the year to June 2011 the Consumer Price Index (CPI) rose 5.3% including a 2.3% rise in the December quarter when GST was hiked to 15% from 12.5%.

"Expectations of CPI inflation fell this quarter with respondents’ mean expectations in both the one-and two-year series dropping below the 3 % mark," the Reserve Bank says. "The one-year series fell from 3.12% to 2.94% this quarter. The two-year series fell from 3.00 to 2.86%. The median of the one-year series is now 2.85 (3.1% last quarter); the 2-year median stays at 3.0%."

JP Morgan economist Helen Kevans noted the pull-back in expectations came amid a decline in oil prices and a stronger New Zealand dollar.

"At 2.9%, the two-year measure remains uncomfortably close to the upper-end of the RBNZ’s comfort zone, reiterating the case for Governor Bollard to unwind the 50 basis point 'insurance' (Official Cash Rate or OCR) cut delivered in March before year-end," said Kevans.

"Indeed, we suspect that Dr. Bollard will hike the OCR 50 basis points in December, having this week pushed out our rate call from a September hike. Our December call is, though, contingent on a normalisation in market sentiment and ebbing of risks around the US and Euro area fiscal situations," Kevans added.

ASB economist Christina Leung said the decline in medium term inflation expectations would be of some comfort to the Reserve Bank. She said there had been some concerns the high headline CPI may have flowed through to higher medium-term inflation expectations and affect wage and price setting behaviour.

"Nonetheless, the RBNZ is likely to remain vigilant for signs of inflation pressures building up in the NZ economy. (Christchurch) rebuilding activity over 2012 is likely to underpin an acceleration in construction costs next year. Indeed, the second quarter CPI report showed a pick-up in construction costs. The RBNZ has noted it would be concerned if these increases were to spill over to generalised inflation," said Leung.

"Pricing intentions and cost expectations in business surveys over the coming months will provide further detail on whether businesses are already starting to factor the likely boost to inflation into their business decisions, and thus the effect on medium-term inflation pressures."

Nonetheless she said the easing in two-year ahead inflation expectations reduces some of the pressure on the Reserve Bank in regards to inflation risks in the domestic economy.

"For now, global risks are dominating the economic outlook, and we expect the RBNZ will hold off raising the OCR by 50 basis points until December this year," Leung said.

The Reserve Bank's Survey of Expectations is a New Zealand-wide quarterly survey of business managers. It's conducted by the Nielsen Company on the central bank's behalf with respondents asked for their expectations of future outcomes of a range of key macroeconomic data. The latest survey was conducted on Wednesday 10 and Thursday August 11.

The Reserve Bank says results of the survey represent expectations held by respondents and in no way represent its views or forecasts.

The central bank said the survey showed a quarterly increase of 0.8% is expected for the September 2011 quarter, down from 0.85% in the previous survey, with a quarterly increase of 0.7% expected for the December quarter.

"These quarterly increases are equivalent to annual inflation rates of 5.0 and 3.3% respectively."