High inflation on low growth ahead

Alan Bollard

The Reserve Bank looks set to stay the course and leave its official cash rate steady at 7.25 per cent this week.

This will raise the question about whether it is right to treat the main causes of persistently high inflation, oil prices and the weaker NZ dollar, as one-offs.

The bank releases its monetary policy statement (MPS) on Thursday, having raised its rate by 2.25 percentage points since January 2004 as it attempts to head off inflation, which hit 3.3 per cent in the year to March.

There was a risk that monetary policy could be held too tight for too long, given economic growth has already undershot Reserve Banks forecasts, said UBS economist Robin Clements.

"The December MPS forecast growth of 3.25 per cent for the year to March just finished," Clements said. "In fact, it might end up being 1.5 if we are lucky, so there is quite a shortfall on the growth front."

New Zealand now faces a period of low growth with high inflation.

"My view is to let the direct effect of those two [oil prices and the low NZ dollar] flow through without them trying to fight it," Clements said.

The disinflationary drag of low economic growth is expected to eventually dominate policy decisions but not until late this year, said Westpac Institutional bank economists.

The rate outlook remains a tug-of-war, and one that is locked in stalemate still, said Westpac economists in an economic commentary.