Inflation probably accelerated in first quarter, keeping OCR hikes on track

New Zealand inflation probably accelerated in the first quarter, keeping on track expectations that the Reserve Bank will lift the official cash rate again next week to mitigate the effects of strong demand growth in coming years.

The consumers price index rose 0.5 percent in the first quarter, for an annual rate of 1.7 percent, according to a Reuters survey and the central bank's latest estimate. That would mark the fastest annual rate since the fourth quarter of 2011.

Reserve Bank governor Graeme Wheeler raised the OCR to 2.75 percent last month, heralding the start of a tightening cycle with the first hike since 2010, and is expected to lift the rate to 3 percent next week. The rate of inflation and the bank's policy response will depend on the behaviour of households and businesses in an economy where construction activity and migration flows are growing, and where loan restrictions have yet to conclusively show up in cooling house prices.

The Reserve Bank expects annual inflation to reach 2 percent this quarter, the mid-point of its target range, before creeping higher by the final three months of 2015. Some bank economists see a faster pace of inflation, given what is seen as a broad-based economic recovery.

The BNZ-BusinessNZ Performance of Composite Index, which combines the manufacturing and services indexes, jumped 5.1 points to 58.4 in March. Taken together with growth in building consents that suggests "upward pressure on inflation, given current limited spare capacity," Bank of New Zealand economist Doug Steel said.

All of the acceleration in inflation is coming from the non-tradable sector of the economy, including housing related costs and a 10 percent hike in the tobacco excise. ASB chief economist Nick Tuffley expects non-tradable inflation of 1.3 percent in the first quarter, more than offsetting a 0.3 percent decline in tradable inflation in the face of a strong kiwi dollar.

The NZIER's March 2014 Quarterly Survey of Business Opinion, released last week, showed that a net 37 percent of those polled expect average selling prices to rise in this quarter. That's the highest since the second quarter of 2010, when it reached 40 percent, and is above the long-run average of 32 percent.

"Inflation turned a corner last year, and is now increasingly back in focus given signs of capacity pressures," Tuffley said in a preview of the inflation data. He expects annual inflation to peak at 2.5 percent in 2015, above the Reserve Bank's track, partly on expectations the New Zealand dollar will weaken in coming years, ending the mitigating influence from tradable deflation.

The trade-weighted index was recently at 80.45, well above the 78.4 level the central bank is expecting it to average in the first half of 2014, according to last month's monetary policy statement. The Reserve Bank has the TWI reducing to 76.6 by the first quarter of 2016.

(BusinessDesk)