KEY POINTS:
Holding out for interest rates to start falling so your mortgage payments decrease? Well, keep waiting.
Inflation numbers due out next week are unlikely to encourage Reserve Bank governor Alan Bollard to ease up on the official cash rate (OCR) when he fronts the financial media seven days later.
Inflation is steadily creeping upwards, with economists saying that the implications of the Government's new carbon emissions trading scheme will keep pressure on interest rates for some time.
Cuts in the OCR are looking more unlikely this year. ASB Bank's economist Nick Tuffley picks March next year as a possible starting point for a round of cuts.
There's a growing chance of more rate rises this year, especially given Reserve Bank fears of a change in public perceptions, or what Tuffley describes as "behavioural spillover".
"Having inflation back at or above the top of the 1-3 per cent target band will concern the RBNZ," he says.
"In recent years, inflation has - with only brief exception - been above the mid-point of the target band. Unsurprisingly, inflation expectations have drifted up."
There are a lot of underlying capacity pressures in the New Zealand economy, says Tuffley, with oil and food prices prices increasing and the "looming introduction of the emissions trading scheme".
The scheme is estimated to mean a hike in petrol and electricity prices of 0.3 percentage points next year, followed by a 0.4 per cent jump in 2010.
"The fuller effect is likely to be even higher, but still very uncertain at this stage," says Tuffley. "With the inflation outlook so high and risks of behavioural shifts rising, it is a higher than expected Q4 inflation outcome that will provoke the most reaction from the market and the RBNZ. As it is, OCR cuts are looking less likely in 2008, more a story for 2009."
The Government says the overall effect on the economy from introducing an emissions trading scheme "is expected to be negligible", with economic modelling predicting it "will knock 0-1 per cent off gross domestic product growth of 15 per cent between 2005 and 2010".
One thing Tuffley thinks might cause real concern for the Reserve Bank is the way high inflation affects behaviour - as workers ask for pay rises and businesses lift their prices. The public's view of where inflation sits is an important driver for inflation itself.
In the 1980s and 90s, inflation was driven down, as were expectations of what it would be - no more 10-15 per cent, but instead 2-3 per cent.
"As long as you think inflation is around 2 to 3 per cent, wage increase expectations will remain in line with that," says Tuffley. "Firms won't be trying to ramp their prices massively, there's an expectation that prices won't move that much."
The 1-3 per cent band, which is likely to be breached this year, was important when inflation was being aggressively pushed down by the Reserve Bank - it was about educating New Zealanders that inflation was going to fall.
"What the Reserve Bank is concerned about now is that, because we have gone through a period where inflation has been a little bit on the high side, we're starting to experience price rises over the past couple of years in the things you notice."
Increases in the prices of petrol and food particularly upset people - both are bought frequently and people are quick to notice.
"They will see there is more of a risk of behaviour shifts," says Tuffley. "There's more risk now we think inflation is higher than we used to think.
"If we all start thinking that inflation is going to be a lot higher in the future than over the past 15 years, there's the risk we're a bit more aggressive in demanding wage rises, and businesses are more aggressive in pushing prices up.
"You get into that inflation spiral. It becomes a vicious circle. The more we start to think inflation's higher, the more likely it is that's what eventuates. You just don't get anywhere except high inflation.
"In the first half of this year, the risks are more tilted towards the Reserve Bank lifting rates rather than dropping them.
"The bank doesn't have that much headroom. In fact, you could argue it doesn't have any."
The most recent jump in petrol prices has "almost guaranteed" inflation above 3 per cent, he says.
"The Reserve Bank won't necessarily react to that, but it is concerned about how that affects our thinking, our psyche."
Similar fears from last year were not borne out, but inflation this year could prove to be "a bit stickier", says Tuffley.
A Reuters poll of 13 economists showed the consumer price index (CPI) likely rose by 1 per cent during the October-December quarter, double the 0.5 per cent gain seen in the previous quarter. It was lifted by higher oil, food and housing costs.
The annual rate is predicted to jump to 3 per cent, the upper band of the Reserve Bank's 1-3 per cent target range, from a three-year low of 1.8 per cent in the September quarter.
"The CPI release will confirm the lack of inflation headroom facing the RBNZ, but we doubt it will be sufficient to force a shift in tone at the January OCR review, when set against the backdrop of the US malaise and weakness in the NZ housing market," says ANZ-National Bank economist Philip Borkin.
The Reserve Bank, which lifted the OCR four times last year to a record 8.25 per cent to cool robust domestic demand, has estimated consumer prices rose 1.1 per cent in the quarter for an annual rate of 3.1 per cent.
Analysts in another Reuters poll unanimously expect the central bank to keep rates on hold at its next review on January 24.
Additional reporting: Reuters
KEY FACTS
* This week sees the release of official inflation figures, with official interest rates announced the following week.
* Westpac chief economist Brendan O'Donovan thinks the figures released on Thursday will show inflation above the Reserve Bank's target range of 1-3 per cent in the consumer price index (CPI).
* The biggest movers in the CPI are expected to be higher petrol prices, increased rents and local body rates. Higher food prices, including dairy and meat, will also contribute to the high rate of inflation.
* Westpac and O'Donovan say annual inflation is likely to be about 4 per cent this year.
* Inflation has averaged 2.9 per cent over the past three years and the Reserve Bank late last year forecast it to stay around that level for two more years.
* Economists think the impact of the emissions trading scheme may add a full percentage point to the CPI for the next three years.
* O'Donovan says the Reserve Bank's forecasts "includes what we think is a conservative estimate of the inflationary effects of the upcoming regional petrol tax".
He says: "We are not sure inflation expectations are anchored well enough to withstand a stream of annual inflation outcomes above the top of the target band." This all means anyone holding out for interest-rate cuts in the near term is likely to be out of luck.
* The Reserve Bank next meets to set the official cash rate (OCR) on January 24.
* Mortgage rates increased last week not, as is usually the case, as a result of the Reserve Bank lifting the OCR, but because of the increased costs faced by the big banks. This is largely because the global credit crunch had made it more expensive to borrow money on world markets.
* ASB Bank economist Nick Tuffley thinks it is unlikely there will be any cut in the OCR during this year. He's picking March next year as a "more conceivable start to the eventual easing cycle".
