Why a tiny inflation miss matters for interest rates

Saturday, 24 January 2026

ANALYSIS: The concern with the higher-than-expected inflation reported by Stats NZ on Friday is that it may be a signal there is something not quite right with the economic recovery that is now supposed to be taking place.

It rarely pays to get too hung up about any sort of economic forecast being off by a fraction of a percentage point.

Stats NZ reported annual inflation at 3.1% in the three months to the end of December, up from 3% the previous quarter.

Delving into the decimal places, the rise was just 0.06 of a percentage point, perhaps within the margin of error.

It’s also important to note that most economists remain confident inflation will trend down this year and return fairly quickly to somewhere within the Reserve Bank’s 1% to 3% target band.

So we are not exactly in Weimar Republic territory here; people might want to pay more attention to inflation if they are renegotiating their pay, but there’s no need to withdraw a wheelbarrow of cash from the ATM this weekend.

Instead, looking for a while on the dark side, the worry may be that the economy that most economists thought was stone cold a few months ago was actually warmer than they thought.

Infometrics principal economist Brad Olsen said on Friday the “acceleration in inflation, despite clear spare capacity in the economy, should start to raise concerns at the Reserve Bank”.

But the stubbornness in core inflation that he pointed to could also be an early sign that spare capacity in the economy has not been as large as has been widely assumed.

The surprise finding from an otherwise remarkably upbeat Quarterly Survey of Business Opinion published by the New Zealand Institute of Economic Research earlier this month was that more firms were reporting difficulties finding skilled staff.

Its principal economist Christina Leung went as far as to say it was seeing pockets of labour shortages starting to emerge.

What could this mean?

The good news is that economists remain confident there is a cyclical recovery taking place in the economy.

A Reserve Bank modelling tool is currently forecasting economic activity will grow by an impressive 2.3% in the six months to end of March, for example.

The bad news is that few believe the actual productive capacity of the economy has been growing at anything like that pace, if at all.

Why would it? Business investment has long been in the doldrums and we are not seeing an explosion of competition in existing industries.

So it may be that stubborn inflation and hints of skills shortage are early signs that the economy will knock up against the lid on growth earlier than expected.

If that is the case, then the Reserve Bank is sitting in a slightly uncomfortable position, with the OCR sitting well below the rate of inflation — negative 0.85% in “real terms” — at a time when there might not be as much left to stimulate as it thought.

On November 20, midway through the December quarter, the bank had been forecasting inflation would come in at 2.7% that quarter. That’s a reasonably significant miss.

And as recently as a week before Christmas, its newly-appointed governor Anna Breman was telling RNZ “there is still a small probability, but it’s still a probability, that we’ll do another rate cut in the near term”.

That seems almost laughable now. Instead, it is looking increasingly likely that the bank made the common mistake of overshooting the monetary cycle, when it cut the OCR by 25 basis points in November.

The market is pricing-in 50 basis points of rate rises this year and history suggests that when central bank forecasts and market pricing strongly diverge, it is the market that is most worth listening to.

These will be tricky times for the bank.

Breman will still be trying to get a full read of the New Zealand economy and its institutions, and good advice may be harder to come by.

The bank shed a lot of staff through restructuring last year, and with it some capability in at least its non-core functions.

Friday’s inflation print suggests she will need to disappoint Finance Minister Nicola Willis by kicking off a cycle of interest rate rises ahead of this year’s election. If so, the messaging will be difficult.