Inflation expectations fall sharply

The Reserve Bank has released its quarterly survey of expectations and it shows a significant fall in expected inflation.

Respondents now expect inflation will be at 1.63% in two years’ time, as compared to the 1.85% recorded in the last survey.

Westpac chief economist Dominick Stephens said it is the lowest ever level of inflation expectations relative to the inflation target.

“We have been expecting inflation expectations to fall for some time, but the size of today's drop took us by surprise.”

Inflation has been below the 2% mid-point of the RBNZ's inflation target band for some time.

Stephens said the RBNZ has argued that the drop in inflation is temporary, and that monetary policy is on track to achieve 2% inflation in the future.

But crucial to their argument was that, even when inflation was low, inflation expectations remained close to 2%, he said.

“Falling inflation expectations across market- and survey-based measures is now calling that argument into question.

“Low inflation expectations may start to impact wage claims and price setting behaviour, in turn leading to even greater downward pressure on inflation.

Westpac is forecasting that inflation will fall to -0.1% by September 2016 – which could lead inflation expectations to fall further.

Stephens said the data is a very important development for the OCR outlook

“It further substantiates our long-held call that the OCR will fall below 2.5% this year.”

While he expects an OCR cut in June, he said the data means the RBNZ could move sooner and cut in March.

However, in a published comment, ANZ took a different view.

The bank said they were coy about reading too much into recent shifts in inflation expectations, particularly given the broader picture.

The RBNZ is going to have continued problems hitting its inflation target, as will central banks around the world, and inflation expectations will be prone to drifting in such an environment, ANZ said.

“Cutting the OCR in the face of greater leveraging behaviour, solid consumption growth, and double digit house price growth is the recipe for an accident.”

ANZ said the RBNZ’s emphasis on flexibility, as opposed to a mechanistic approach, when fighting inflation was appropriate.

For this reason, the bank doesn’t expect the RBNZ to be too concerned over the dip in inflation expectations.