The Reserve Bank is reiterating it will cut interest rates further if consumers and businesses keep thinking low inflation is here to stay.
Reserve Bank of New Zealand Photo: RNZ / Alexander Robertson
The bank has published a new paper on the issue of inflation expectations, how they are measured and why they matter for monetary policy.
The issue featured prominently in last week's monetary statement and the surprise decision to cut the official cash rate to 2.25 percent.
- Listen to an interview with Reserve Bank Governor Graeme Wheeler after last week's announcement of a further rate cut - by RNZ Economics Correspondent Patrick O'Meara.
Reserve Bank of New Zealand (RBNZ) assistant governor and head of economics John McDermott said the concern was that if people thought low inflation was here to stay they would factor that into prices, wages, and spending decisions.
"In a very low inflation environment, where we are today, they (businesses) will understand that their competitors will not be putting up prices too often and they will fear that if they put up prices they will lose market share."
He said the rapid fall in inflation expectations seen in various surveys, and other indicators such as bond prices, were a key factor in the rate cut last week.
Recent surveys have shown expectations of inflation were just above 1.5 percent over the next 12 to 24 months, a level which the RBNZ had previously said was a worry.
Ideally consumers and businesses would factor in an inflation rate of around 2 percent, which was the middle of the RBNZ's target range, Mr McDermott said.
Consumer inflation fell to a 16-year low of 0.1 percent in December, driven by the sharp fall in oil prices. The RBNZ's own estimate of underlying inflation puts the rate at around 1.6 percent.
He said inflation expectations were central to RBNZ's thinking, and if they kept falling, then interest rates would be cut again.
"That's exactly the message," Mr McDermott said.
Analysts expected the RBNZ to cut its cash rate at least once more this year, probably around June, but there was a minority view that the rate could be down to 1.75 percent by the end of the year.
