Inflation tipped to hit target

A return of inflation this year will add pressure for the Reserve Bank to raise interest rates from record low levels.

Rising petrol prices are tipped to have boosted the consumer price index (CPI) – the common measure of household inflation – in the final months of 2016.

Official figures due to be released on Thursday are expected to show inflation rose to about 1.2 per cent in 2016.

While this is low by historic standards, it will mark the highest level in 21⁄2 years, and the first time since mid-2014 that inflation has been within the range the Reserve Bank is meant to target.

In 2016 the Reserve Bank slashed the official cash rate (OCR), which influences the interest rates on savings and mortgages, to an all-time low of 1.75 per cent, amid fears that low inflation would lead to a downward spiral in inflation expectations.

Last week, the influential quarterly survey of business opinion (QSBO) showed a sharp increase both in the proportion of businesses that were able to put up prices at the end of 2016, and of those expecting to raise prices in the first quarter of 2017.

Bank of New Zealand, which is forecasting that by the end of March annual inflation will have hit 2 per cent, said a return of inflation would call into question the extent to which the Reserve Bank cut interest rates in 2016.

BNZ senior economist Craig Ebert said an economy growing strongly, rising house prices and strong business and consumer confidence were at odds with the current OCR.

‘‘It wasn’t too long ago that the Reserve Bank was describing a 2 per cent [official] cash rate as consistent with recession,’’ Ebert said.

‘‘The OCR is where it is because the Reserve Bank was quite fearful of inflation sagging and dragging down with it inflation expectations. So if that [inflation] fear is not really there … then it does start to question the extent to which the Reserve Bank eased [interest rates] last year.’’

While BNZ does not expect the Reserve Bank will in fact raise interest rates until 2018, Ebert said inflation should prompt governor Graeme Wheeler to move earlier.

The pricing of financial instruments suggests the market sees about a 50 per cent chance that the OCR will be increased in August, with the odds higher for a rise by the end of the year.

While Westpac also expects figures will show inflation rose above 1 per cent at the end of 2016, the bank believes a recent rise in the New Zealand dollar is likely to mean inflation will stay near 1 per cent for some time.

Westpac warned that the QSBO results may paint a false picture about the risks of rising inflation.

A large proportion of businesses predicting price increases were in the services sector, which is heavily influenced by financial services companies, a sector which might simply be responding to already rising interest rates.