Inflation is well below the bottom of the Reserve Bank's target 1% 3%, barely registering at 0.1%, but concerns are mounting there could be an inflation spike on the way.
BNZ head of research Stephen Toplis said many were ''scurrying'' to lower their GDP expectations, given the plummet in dairy prices, construction activity in Canterbury peaking, with the flow on impact of both feeding through the wider economy.
''In addition, interest rate expectations are plummeting,'' Mr Toplis said in a statement.
''The biggest shock to the economy has been the ongoing demise of the dairy sector,'' Mr Toplis said.
Because of the further slump in the latest dairy auction price last week and confirmation that the ban on dairy imports into Russia, from the EU, the US and others will continue, Mr Toplis had lowered the BNZ's expected 2015 16 milk price forecast, from $5.70 to $5.20 per kg.
''Unfortunately, downside [negative] risks remain. Our forecast is still reliant on some pricing recovery over the next 12 months,'' he said.
Mr Toplis said the BNZ's GDP forecasts were already on the pessimistic side of consensus, and lower than the Reserve Bank's.
He is forecasting annual average GDP growth of 2.4% for calendar 2015, following a 3.3% increase in 2014, and over the next two years, forecast growth averaging 2.1%.
The income effect of the dairy decline feeds through to the wider economy, adversely impacting private consumption, investment and government revenues, Mr Toplis said.
''So, while agriculture production is not significantly impacted other parts of GDP most definitely are,'' he said.
In part, the demise of dairy will be having an impact on economy wide confidence''And it's not only agriculture where this shows up.
There is a notable softening in construction expectations as the contribution to growth from the residential component of the Christchurch rebuild begins to peak,'' Mr Toplis said.
We have been warning for some time now that there was a very real chance that GDP growth would falter, the New Zealand dollar would respond, and that the falling dollar might create an inflation problem, even as economic activity diminished.
''In our opinion, this process is now well in train,'' Mr Toplis said. As at the Reserve Bank's last monetary policy statement, inflation was already forecast to rise to the mid point of the bank's target band - 1% 3%.
''The recent slump in the exchange rate must surely push that forecast higher,'' Mr Toplis said.
He said the Reserve Bank had its work cut out, given the risks around GDP growth falling to zero while coinciding with the possibility that inflation heads to 3% - and that was before it has to consider the impact of the booming housing market.
