KEY POINTS:
The Reserve Bank is holding out little hope of relief for borrowers despite taking a much darker view of the economy's growth prospects.
It left the official cash rate on hold at 8.25 per cent yesterday and said it needed to stay there for "a significant time yet".
It has slashed its growth forecasts to 1.9 per cent over the year ahead and 1.7 per cent the next year, from 2.7 and 2.4 per cent respectively three months ago.
It admits it may turn out worse than that, if the international economy and the local housing market deteriorate more than it expects.
But inflation at 3.2 per cent is back outside the bank's target band. It is expected to stay there all this year and decline only slowly after that.
"We are faced with high probability but modest upside risks to inflation, offset by lower probability but potentially severe downside risks to activity," it said.
Bank of New Zealand head of research Stephen Toplis translated that as: "There are still inflation problems but we don't see them getting much more severe. Hence we no longer feel the need to contemplate a rate increase. On the other hand there is a growing risk that the economy implodes. If that happens we will be ready to react but, given the inflation risks, conditions will have to be really bad before we do so."
The inflation hawks at Westpac have dropped their forecast of another two rises in the official cash rate, on the grounds that the equivalent has already been delivered by the global credit crunch pushing up the cost of funding to New Zealand banks.
The average mortgage rate is at its highest for nearly 10 years, 1.6 percentage points above its lows in late 2003.
Toplis said it was quite conceivable that lending rates, including mortgage rates, could rise by another half a percentage point.
"And that's the good news. For some, the supply of credit will simply dry up."
Comments by both the Governor Alan Bollard and his deputy Grant Spencer yesterday indicated they see the tightening credit conditions as an appropriate correction after a period in which risk had been excessively discounted.
"There is some evidence [the banks] are being more conservative about lending to households and businesses too," Bollard said. "That's not inappropriate."
The bank expects house prices to fall about 5 per cent this year and stay below current levels for two or three years.
With house prices still overvalued - by 20 to 30 per cent it, believes - more pressure on interest rates and the availability of credit could deliver a more marked downturn in the housing market.
But only if that eventuated and the world economy slowed more than it expected and dry weather persisted for some time yet would the situation start to resemble the 1998 recession, it said.
The bank cites a list of factors keeping upward pressure on inflation: a tight labour market, strong commodity prices, Government spending plans and the prospect of tax cuts, and the emissions trading scheme which will incorporate a price of carbon into petrol from the start of next year and electricity year later.
In the light of that, it concludes, it cannot afford an "insurance" cut to interest rates.
WEAKER GROWTH
* Slowing world economy.
* Credit squeeze.
* Sagging housing market.
* Drought.
BUT STICKY INFLATION
* Tight labour market.
* High export prices.
* Tax cuts.
* Emissions trading scheme.
