Inflation expectations improve but still too high

Businesses' inflation expectations have improved slightly but remain uncomfortably high, economists say.

Tuesday, August 23rd 2011, 4:21PM

by Jenny Ruth

The Reserve Bank's latest survey of expectations shows businesses now expect two year ahead inflation will be 2.86%, down from 3% three months ago.

That's even though they're expecting the economy to grow much faster, at 2.9% in each of the next two years, down from the 2.1% growth for the next year they were expecting three months ago.

"It's (inflation expectations) down, but it's really quite fractional," says Craig Ebert, an economist at Bank of New Zealand.

"Essentially, these indicators are knocking on the ceiling - as soon as you get any growth in the economy you're going to be running inflation above tolerance levels. Normally, at this stage in the cycle, you would expect to see expectations down around their ankles," Ebert says.

"The starting point must be worrying. You just don't have any headroom."

Chris Tennent-Brown at ASB Bank says the slight dip in expectations isn't so surprising because of the stronger New Zealand dollar and the recent fall in oil prices.

Darren Gibbs at Deutsche Bank says while a decline is better than an increase, inflation expectations are still higher than Reserve Bank governor Alan Bollard would like.

All other things being equal, today's survey would likely prompt Bollard to start raising interest rates at his next review on September 15 but he probably won't because of the turmoil in global financial markets, Gibbs says. Gibbs is picking Bollard will hold off until March next year but concensus is for a rate rise in December.

However, Annette Beacher at TD Securities says given inflation expectations remain "sticky," Bollard's message that the rise in GST last October shouldn't translate into higher prices "is still not sinking in."

She says Bollard has strong grounds to reverse the "emergency" move in March when he cut his official cash rate (OCR) from 3% to 2.5% following Christchurch's second major earthquake.

But after that she expects Bollard to sit on the sidelines well into 2012 "to assess the impact of persistent negative offshore headwinds on the outlook for exports and commodity prices.