The Bank of New Zealand has warned that declining fuel prices may add to medium-term inflation pressures rather than providing relief, potentially sustaining upward pressure on interest rates.
BNZ head of research Stephen Toplis suggested markets may be underestimating the inflation risk by concentrating too much on the immediate effect of lower prices at the pump. "It misses the point that if oil prices fall, it puts money back into the pockets of New Zealanders, which gives them the ability to increase spending. And that increases domestic demand," Toplis said.
The ANZ-Roy Morgan Consumer Confidence survey rose sharply in May after fuel prices eased. Before the recent Middle East conflict, the economy was already experiencing demand pressures, with confidence rising and the Reserve Bank indicating further rate hikes.
BNZ cautioned that the same pattern could emerge again if dropping fuel prices revive confidence and demand. While cheaper petrol would probably reduce near-term inflation, the bank said the larger risk lay with medium-term inflation expectations.
The Reserve Bank's May Monetary Policy Statement did not include lower energy prices in its forecasts. Toplis said the central bank knows how to address demand-driven inflation: "They raise interest rates."
He said the Reserve Bank would seek to ensure policy settings were not stimulatory before ending its tightening cycle, estimating that 3 or 4 rate increases by the end of the year would probably be enough.