2010.08.1906:58:00UTC+00Spike In New Zealand Inflation To Be Short-Lived, Bollard Says

Reserve Bank of New Zealand Governor Alan Bollard on Thursday said the spike in the country's inflation will be short-lived.

Bollard told firms to base their pricing decisions on low underlying inflation and not on the upcoming temporary rise. He warned that if businesses, labour groups and households use the upcoming hike in the Goods and Services Tax as a veil to increase margins and wages, they will simply spread inflation and harm the recovery.

In a speech to the Taranaki Chamber of Commerce, he said, "As the economy grows, employment levels will increase, and plant and equipment will be worked harder." But, he expects inflation to remain comfortably within the target band in the second half of the central bank's forecast horizon.

Although the increase in the rate of GST will push headline inflation substantially higher, Bollard said the inflationary effects should be largely out of the system by later next year. According to him, the expectation of the peak in inflation has eased back to "around 5% or just below." In June, the central bank had projected it to peak at 5.4%.

While higher headline inflation would pose a challenge for monetary policy, the RBNZ's Policy Targets Agreement with Government allows it to "look through" temporary inflation spikes, Bollard said. It is assumed that the coming policy changes will have only limited impact on perceptions of future inflation.

Monetary policy would need to respond if inflation expectations and prices were ratcheted up considerably. This would lead to higher interest rates and ultimately dampen the economic recovery, Bollard noted. "We are hopeful this will not need to be the case, so that monetary policy can play as full a part as possible in supporting economic growth."

"Even without a significant rise in inflation expectations, our forecast remains for another two rates hikes this year, with the most likely month for a pause being October." J.P. Morgan economist Helen Kevans said. A notable increase in inflation expectations would mean that Bollard has to tighten policy more aggressively in 2011 than currently estimated, the economist said.

Today, a report from Statistics New Zealand showed a 1.1% sequential rise in producer output prices during the June quarter, down from a 1.8% increase in the March quarter. Meanwhile, producer input price rose at a faster pace of 1.4% after climbing 1.3% in the prior quarter.

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