Falling prices and inflation point to an economy slowing in December with warnings coming that further falls in inflation could see a further slowing in the economic recovery.
Statistics New Zealand figures released yesterday showed that the Consumers Price Index (CPI) - the official measure of inflation - fell to 0.3% in the three months ended September, to take the annual rate down to 1.8%, well below the Reserve Bank's expectation of 2.6%.
ANZ-National Bank chief economist Cameron Bagrie said the CPI was the second successive negative surprise for the Reserve Bank with the fall in consumer prices weaker than expected.
Inflation was now "comfortably" within the Reserve Bank's 1% to 3% target band as the GST impact dropped out of the annual comparison. Prices fell in five of the 11 CPI groups, suggesting that lower food prices in December were not the sole culprit for lower inflation, he said.
Large negative quarterly contributions were evident for communications - due to lower internet charges - and household contents and services.
There was evidence of the soft retail environment weighing on prices, Mr Bagrie said.
Prices fell for furniture, kitchenware and appliances which pushed down prices in the household contents band services group. Audio-visual prices fell a sizeable 3.4%. Even prices for apparel and recreational and cultural equipment bucked the usual seasonal pattern and trend.
Increases in the insurance component were a relatively modest 0.7% in December, following the 2.4% increase in September, he said.
Encouragingly for the Reserve Bank, inflation in the housing components was moderate with construction costs posting a 0.4% increase and rents also up 0.4%.
The key focus of the Reserve Bank would remain medium-term inflation, Mr Bagrie said.
Domestic activity and near-term inflation both looked to be even weaker than assumed in the bank's December monetary policy statement. The world outlook was also arguably weaker.
However, much of the downward price influences did not appear persistent, which raised the possibility of a reversal of food falls in subsequent quarters.
Two weak inflation results begged the obvious question of what the next move on the OCR would be, he said.
The risk profile for the the global economy pointed to a cut in the OCR and that would keep the market biased that way.
"In our mind, the hurdle for an OCR cut remains pretty high. With annual core inflation running around 2% at present, the real OCR is 0.5%. This represents powder that should be kept pretty dry as a sort of insurance policy against extreme rate-risk results."
That did not mean the Reserve Bank was doing nothing, he said.
Each day the OCR remained on hold lowered the effective borrowing rate.
ANZ-National Bank estimated the average fixed mortgage rate rolling off at present was around 6.7%, a sizeable gap from where current floating rates were sitting at around 5.74%.
Monetary policy was easing by stealth and the housing market was responding, Mr Bagrie said.
The New Zealand dollar reacted negatively to the low inflation and the currency could remain under pressure in the short-term. Mr Bagrie saw that as a knee-jerk reaction to weak data and the likelihood OCR cuts would be priced in with greater intensity.
"We'd caution against getting too bearish on the New Zealand dollar."
