KEY POINTS:
Reserve Bank governor Alan Bollard is expected to leave the official cash rate at 8.25 per cent on Thursday, but the markets will be looking for a steer on what he sees as the greater danger at this point: growth at a standstill or inflation still running hot?
The near-term inflation outlook looks worse than it was three months ago.
International oil prices are almost 40 per cent higher than the Reserve Bank had assumed.
"At a time when inflation expectations have risen to a hair's breadth from the top of the inflation target band, the bank can scarcely afford to ignore the impact that $2-a-litre petrol has on people's impressions of inflation," Westpac chief economist Brendan O'Donovan said.
Swaps market pricing now implies Bollard will not start cutting the OCR until December, with three cuts priced in by April next year.
But the market is volatile. Less than a month ago, after a flurry of weak economic data, the same market briefly saw a 50:50 chance that the easing cycle could start as soon as this week.
For once, economists are taking a more aggressive view than the dealing rooms. In a Reuters poll on Friday, 12 of the 17 forecasters surveyed expect the bank to have started cutting rates by the end of September and all but one (Westpac) expect the easing to be under way by the end of the year, with rates a full percentage point lower than now by the end of March next year.
Since the bank last reviewed the OCR in April almost all the economic news has been bad.
In real terms retail spending contracted in the March quarter, to an extent not seen since 1997.
One reason is that petrol and food prices have continued to climb, crowding out spending on more discretionary items.
Another is the "pipeline" effect, where people with two-year fixed-rate mortgages maturing are suddenly confronted with the fact that in the meantime there have been four increases in the official cash rate and a global credit squeeze. The result is they are rolling off a rate around 8 per cent to one around 9.5 per cent.
The housing market has continued to weaken. "The Reserve Bank's [March] forecasts of around a 4 per cent fall in house prices over 2008 risks being too modest," said ASB chief economist Nick Tuffley.
The labour market has also turned south, sooner and more sharply than expected. The economy shed 29,000 jobs in the March quarter.
But there was not a corresponding rise in the number of people looking for work, which might have relieved some pressure on inflation.
ANZ National Bank chief economist Cameron Bagrie said the labour market tended to be a lagging indicator. "The fact that it weakened early portends more softness in the economy to come."
As do consumer and business confidence, which are at recessionary levels.
And the hydro lakes are perilously low, raising the risk that businesses and possibly households will have to reduce consumption this winter.
On the positive side of the ledger are a Budget more stimulatory than expected and a lift in Fonterra's dairy payout.
Over the next two years - the period of most concern to the central bank - the tax cuts are not a great deal larger than had been pencilled in six months ago.
But when combined with an increase of nearly 8 per cent in Government spending next fiscal year and the decision to delay the introduction of transport fuels to the emissions trading scheme, the net effect is a stronger fiscal stimulus than the economy has seen since 1997.
Bagrie suspects the Reserve Bank will see the tax cuts and Fonterra payout as merely helping to provide a floor to growth rather than adding further to inflation pressure.
WHAT'S IN STORE
* The Reserve Bank's June monetary policy statement will leave interest rates on hold.
* It will balance a weaker growth outlook with continued concerns about inflation.
* It is expected to maintain April's signal of a shift to an easing bias.
* But only enough to prop up market expectations of a December rate cut.
