A test of inflation targeting credibility?

The most recently released New Zealand inflation expectation surveys compound the Reserve Bank's headache over persistently low inflation.  On balance, in our view, these help keep the door open for further cuts in the Official Cash Rate (OCR), as soon the next March meeting.

Back in January, headline annual NZ CPI inflation for 2015 Q4 came in lower than expected at just +0.1%, well below the bottom of the RBNZ’s target range.

In the face of stubbornly low headline inflation, the RBNZ have been at pains to emphasise that core inflation measures (that strip out volatile items) and inflation expectations remain well anchored.  This helps justify their decision to look through the current low headline CPI inflation numbers, and instead focus on achieving future inflation outcomes.  As if to underline this point in bold print, in a recent speech the Governor took aim at critics of the RBNZ that take “a mechanistic approach” that leads to “an inappropriate fixation on headline inflation”.

For many years, the RBNZ’s favoured measure of the NZ CPI inflation expectations was its own survey of expectations two years ahead.   For much of Alan Bollard’s tenure as Governor this averaged around 2.5%, which in part motivated the inclusion of a new phrase in the Policy Targets Agreement (PTA) to “focus on keeping future average inflation near the 2% target midpoint”.