NZ Inflation Cools, Kiwi Drops from 11-Week High

Annual inflation in New Zealand unexpectedly fell to three-year lows in the third quarter, knocking the currency off 11-week highs but supporting the view that the central bank will keep interest rates on hold.

Annual inflation cooled to 1.8% -- its lowest since March quarter 2004 -- from 2% in the previous quarter and a key measure of domestically generated price pressures also
eased, data showed on Monday.

The lower inflation rate was helped by one-off factors,  including falling health and education costs. Still, the central bank would remain wary of underlying inflation pressures, analysts said.

"It helps to give them a little bit of breathing space," said  Khoon Goh, senior economist at ANZ-National Bank.

"However, they'll remain concerned because they don't want to continue to rely on one-offs to take inflation down to their target rate."

The surprise fall in inflation knocked the New Zealand dollar , which has been supported by the country's high official interest rate of 8.25%, more than half a cent down from an 11-week high of $0.7787.

The yield on the December bank bill contract settled 4 basis points lower at 8.65%.

The consumer price index rose 0.5% during the July-September quarter, below the 0.8% gain forecast by the central bank and by economists in a Reuters poll.

The Reserve Bank of New Zealand, which had forecast an annual rise in prices of 2.1%, is required to keep annual inflation in a 1-3% range on average over the medium term.

Although inflation has held below the upper end of that range since the July-September quarter of 2006, the central bank has lifted interest rates four times this year to 8.25% due to concerns over robust domestic spending, particularly in the housing market.

Higher Inflation Expected

The central bank has forecast that annual inflation would jump to 3% -- the top of its target band -- in the October-December quarter as the impact of rises in oil prices
last year fall out of annual calculations, and then hold around that level through 2008.

But since then, data has shown the economy grew faster than expected in the second quarter. It expanded a seasonally adjusted 0.7% in the April-June quarter, outstripping the central bank's forecast of 0.5% growth and prompting some economists to look for further rate increases this year.

However, in a Reuters poll conducted last week, only two forecasters expected a further rise in the cash rate. Most expected the next move to be downwards, although not until the second half of next year.

Statistics New Zealand said the rise in the headline CPI was driven by rising housing-related costs and food prices, although they were partly offset by health and education costs falling as a result of higher government subsidies.

"If you take those one-offs out of the equation on the premise that they are not going to be repeated, the underlying inflation pressures are still intense," said Westpac Bank economist Doug Steel.

Government agency Quotable Value said last week that growth in residential house prices eased for the first time in eight months in September although they were still up 13.2% from a year earlier.   

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