Bank chief sounds warning on inflation

Reserve Bank Governor Alan Bollard has acknowledged inflation is likely to exceed 3 per cent, the top of the target range, but has left the official cash rate at 6.75 per cent.

Announcing the no-change decision yesterday, Bollard noted the easing in economic growth over recent quarters, particularly in sectors such as manufacturing which were exposed to the strong dollar.

But he said the inflation pressures resulting from several years of strong growth would "take some time to unwind".

On top of that, surging oil prices and a waning of the dollar's strength - making imports more expensive - were expected to push inflation temporarily above 3 per cent over the coming quarters.

Nonetheless, Bollard believes the official cash rate is already high enough to achieve his appointed task, which is to keep inflation between 1 per cent and 3 per cent - not at all times but "on average over the medium term".

Deutsche Bank chief economist Ulf Schoefisch said the slowdown in growth should lead to to an easing in underlying inflation pressure, with a lag. "That suggests that riding out the short-term inflation blip above 3 per cent, which can largely be attributed to international oil prices, is the right strategy within the policy framework which is focused on the medium term."

Westpac chief economist Brendan O'Donovan said the breach would be a threat only if inflation expectations galloped away. This week's National Bank survey found inflation expectations unchanged, despite a string of petrol price increases.

In a change from his statement six weeks ago when he said household spending had remained firmer than expected, Bollard said, "It appears household consumption is beginning to weaken".

But the housing market remains a worry. ASB economist Kate Skinner said that without signs the sector was coming off the boil the Reserve Bank would find it hard to believe spending would slow sufficiently to contain inflation pressures.

As expected, Bollard's statement continued to warn that further tightening could not be ruled out and that there was no prospect of an easing in the foreseeable future.

The financial markets are about 80 per cent sure that the next move in the official cash rate will be down, but economists are divided about whether that will come in the first quarter next year or somewhat later.