KEY POINTS:
Reserve Bank governor Alan Bollard is expected to leave the official cash rate on hold on Thursday, with any concerns about the fall-out from financial market ructions being offset by the continuing threat of inflation.
Seventeen economic forecasters polled by Reuters this week were unanimous Bollard will keep the OCR unchanged at 8.25 per cent. Financial market pricing, however, expects interest rates to be 50 basis points lower by this time next year, with the first cut pencilled in for March.
"We expect the bank to express satisfaction with the slowdown occurring in the housing market," said Deustche Bank chief economist Darren Gibbs.
"But the bank will also note that strong trading partner growth - albeit at risk of being tempered by developments in credit markets - record commodity prices and expansionary fiscal policy all have the potential to sustain inflation pressures."
First NZ Capital economist Jason Wong said the direct impact of the collapse of a string of finance companies was not significant as non-bank financial institutions make up a small part of the financial system.
"However the indirect effects are perhaps more important, such as the reduced ability for property developers to borrow, the reduction of very favourable interest-free deals for consumers and more generally just a more subdued outlook for credit growth - not such a bad thing given recent trends of rising debt-to-income and debt servicing-to-income ratios."
The bank would be happy with recent data on the housing market, he said. "On our seasonally adjusted estimates, house sales in July were 22 per cent below the level recorded at the end of last year. Furthermore, median house prices have fallen for two consecutive months."
With mortgage rates above 9 per cent borrowers whose fixed rate loans are coming up for an interest rate reset face much higher costs. But economists point to several factors which will underpin consumer spending:
* The labour market remains tight with the unemployment rate at a record-equalling low of 3.6 per cent in the June quarter.
* Next year's Budget is expected to increase the fiscal stimulus already foreshadowed. "With an election looming, a Government that is behind in the polls and a sound fiscal position, fiscal lolly scrambles seem inevitable," said Westpac chief economist Brendan O'Donovan.
* Any concerns about a slowing of the word economy have yet to show up in export commodity prices. They rose another 1.4 per cent last month and the local gain was amplified to 10 per cent by a weaker New Zealand dollar.
Fonterra has increased its forecast payout by nearly $1 a kilogram since the Reserve Bank's June monetary policy statement.
On a trade-weighted basis the dollar is nearly 8 per cent lower than the average level assumed for the second half of this year in the bank's June forecasts.
"The Reserve Bank will be very happy to let the exchange rate act as the shock absorber, rather than interest rates," O'Donovan said.
"If global growth looked seriously threatened it is highly likely the New Zealand dollar would fall sharply and the Reserve Bank would not stand in its way."
But it would be unlikely to deliver interest rate costs on top of that, given how inflationary a sharp fall in the dollar would be.
ASB chief economist Nick Tuffley said the lower dollar increased the risk that petrol prices would head higher in the context of still-high world oil prices.
That, combined with the fact that years of above-trend spending growth had left the economy's resources stretched tight, suggested that inflation would head rapidly towards the top of the central bank's 1 to 3 per cent target band by the end of the year.
THE BAD
* Credit market jitters could trim trading partner growth, and dent consumer confidence at home.
* The housing market is slowing.
* Net immigration flows are weaker than expected.
AND THE GOOD ...
* The labour market remains tight.
* The dairy sector is booming.
* A fiscal lolly scramble looks on the cards.
OCR 'TECHNICAL CUT' UNLIKELY
The prevailing tightness of credit markets has seen the spread between the official cash rate and 90-day bank bill rates, from which a lot of business loans and floating mortgage rates are priced, widen to around 60 basis points.
When that spread widened rapidly to nearly a full percentage point three weeks ago the Reserve Bank intervened to restore liquidity to the interbank market.
Spreads returned to a more normal 30 basis points after that, but have been rising again, leading to speculation of a "technical" cut in the OCR to bring the rate down again. "We believe the Reserve Bank will try all alternative avenues to improve market functioning before resorting to ... OCR cuts," Westpac chief economist Brendan O'Donovan said.
"OCR cuts would address the symptom [high rates] but not its root cause, which is too little confidence to lend in the interbank market."
Deutsche Bank chief economist Darren Gibbs said the increased spread had not translated into higher wholesale rates down the curve - in fact, they had declined.
