KEY POINTS:
As nervousness about the international outlook offsets evidence of persistent inflation pressure, the money markets see next to no chance that the Reserve Bank will adjust the official cash rate (OCR) at its next review on Thursday.
The official cash rate at 8.25 per cent is already very high by international standards - the average policy rate among the world's 11 major central banks is just over 4.5 per cent - and is the highest it has been since the OCR was adopted as the bank's main lever in the 1990s.
"Market pricing implies very little chance of movement in the official cash rate until the end of 2008 or start of 2009 and we envisage the [Reserve Bank] statement will largely endorse that expectation," ASB Bank chief economist Nick Tuffley said.
First NZ Capital economist Jason Wong said the outlook was for high, above-target inflation for at least the next 12 months, which meant that any easing was out of the question, while the uncertain but clearly negative impact of the global credit crunch meant tightening was also out of the question.
"A tightening of sorts is already occurring anyway, with effective mortgage rates on the rise," he said.
The increased risk premium in wholesale interest rates has raised the cost of funds to banks, which have passed it on in the form of higher mortgage rates.
Since the Reserve Bank last reviewed its official cash rate in December, fixed mortgage rates have risen between 14 and 20 basis points, depending on their term.
Higher interest rates are - at long last - reining in the housing market.
The Real Estate Institute last Wednesday reported that the number of properties sold last month was 32 per cent down on December 2006. The median price at $345,000 was down $7000 on November and only 4.5 per cent higher than a year earlier, a far cry from the double-digit house price inflation of previous years.
Similarly, Thursday's consumer price index data showed a deceleration in inflation in the non-tradeables or inward-facing parts of the economy.
Other than that, there was nothing in the inflation report to reassure the central bank.
Not only was the headline inflation rate at 3.2 per cent higher than it expected, and back outside its target band, measures of core inflation like the trimmed mean (3.5 per cent) and weighted median (3.2 per cent) were high as well. Two-thirds of the CPI's increase was explained by higher petrol and food prices.
"These frequently purchased items carry a greater risk of lifting consumers' inflation expectations over the next couple of years," Tuffley said.
Inflation has averaged just over 3 per cent over the past three years and is widely forecast to remain over 3 per cent through 2008. In the context of a tight labour market the risk is that higher inflation expectations become self-fulfilling, through a wage-price spiral. There was also little joy for the Reserve Bank in the New Zealand Institute of Economic Research quarterly survey of business opinion, released last Tuesday.
The survey depicts an economy which remains capacity-constrained despite the slowdown under way.
Firms reported little spare capacity in physical plant and increased difficulty in finding both skilled and unskilled labour.
And their responses to the survey's questions about costs and pricing intentions would give the Reserve Bank no grounds to feel comfortable, the institute said. But Governor Alan Bollard has to weigh the clear and present danger of inflation at home against the increasingly menacing international outlook.
"Despite the current carnage on global equity markets, we expect the Australian and Asian economies to be relatively unscathed by the US slowdown," Westpac chief economist Brendan O'Donovan said.
"The Australian economy is booming and in Asia low or negative real interest rates are resulting in very high credit growth. So long as this remains the case - and we expect it to - inflation will be New Zealand's dominant problem."
And, he said, while higher interest rates and petrol prices, and the housing market correction, were slowing the New Zealand economy, there were strong forces acting the other way in the form of wage growth, a wall of dairy cash and the prospect of tax cuts.
