Inflation poses awkward policy challenge

NEW Zealand's annual inflation rate probably returned to 14-year lows in the second quarter as a high currency reduced prices of imported clothing and competition drove down telecommunications costs.

The consumers price Index rose 0.3 per cent in the second quarter for an annual pace of 0.8 per cent, according to a Reuters survey of 10 economists ahead of the report's release on Tuesday.

The annual rate would match the level of the third quarter last year, which was the lowest since the final quarter of 1999, a year marked by nine months of deflation.

It would also give the central bank little reason to bring forward the timing of interest rate increases, even though it suspects inflation pressures are building in the housing market and from a Kiwi trade-weighted index that has tumbled from its second-quarter highs.

"The low annual pace of current inflation presents an awkward policy challenge for the RBNZ," said Nick Tuffley, chief economist at ASB.

"Continued downside inflation surprises may reduce the RBNZ's confidence of a lift in future inflation pressures," Mr Tuffley said.

Inflation is contained in the central bank's 1 per cent-to-3 per cent target range, and traders see no chance of a rise in the official cash rate of 2.5 per cent at the next review on July 25.

However, they see 47 basis points of hikes in the next 12 months - equivalent to about two quarter-point increases, based on the Overnight Index Swap curve.

Fuel costs rose to a record high this week but in the second quarter they fell.

Westpac senior economist Michael Gordon said the second quarter may be the last of persistently low inflation.

The Reserve Bank agrees. Its June monetary policy statement has inflation speeding to 0.6 per cent in the third quarter and an annual pace that increases to 1.1 per cent.

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