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Plunging inflation expectations could lead to interest rates being cut to a record low within a month.On Tuesday the Reserve Bank released its quarterly survey of expectations, which showed expectations for inflation over the next two years plunging to a 22-year low.
Back in December the survey showed two year inflations of 1.85 per cent, but this dropped to 1.63 per cent in the March 2016 quarter.
Despite the consumer price index falling to 0.1 per cent in 2015, economists all but ruled out the Reserve Bank cutting interest rates following a speech by Governor Graeme Wheeler in early February, when he pointed to inflation expectations staying close to 2 per cent, the mid-point of the 1-3 per cent target.
Westpac chief economist Dominick Stephens said the inflation expectations survey was at its lowest reading since 1994, when the inflation target was 0-2 per cent.
"This is certainly the lowest ever level of inflation expectations relative to the inflation target," Stephens said.
"We have been expecting inflation expectations to fall for some time, but the size of today's drop took us by surprise."
Stephens was the first major bank economist to predict the Reserve Bank would drop the official cash rate (OCR) below to 2.5 per cent, which would represent a record low, and on Monday he said the latest development opened the door to a March 10 cut.
"We currently expect the first OCR cut to occur in June, but today's data raises the risk that the [Reserve Bank of New Zealand] could move sooner - March is certainly still a live possibility for an OCR reduction."
ASB, which also expected the OCR to eventually cut to 2 per cent, said the Reserve Bank had been "too complacent" about the weakness of inflation.
The bank expects interest rates to be lowered in June and August, but Tuesday's survey "skews the risks to an earlier start", ASB senior economist Jane Turner said.
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