Brian Fallow: Bollard changes his tune as growth prospects dim

Alan Bollard has scaled back expectations. Photo / Mark Mitchell

If Alan Bollard's interest rate decision yesterday had needed a theme song, it would have been the Rolling Stones' Time is on My Side.

As universally expected, he left the official cash rate unchanged at 3 per cent - a decision already taken on an interim basis, he said, the day before the Canterbury earthquake.

Running through the accompanying monetary policy statement are words like "gradually", "progressively" and "eventually".

The Reserve Bank has substantially revised down its forecasts for growth and its interest rate outlook with it.

GDP growth over the next three years is now forecast to average 2.7 per cent - excluding the impact of the earthquake.

That is forecast to boost GDP by between 0.5 and 1 per cent over the next 18 months, though Bollard counselled that such estimates were based on "heaps" of assumptions at this stage, and that the increase in activity was only to replace what was lost and would not leave the country better off than it would have been without the disaster.

The bank has halved the extent of the interest rate rises it foreshadows over the next three years, compared with the June statement.

Its forecast track now has 50 basis points of increases over the year ahead and another 50 the following year. Where it used to resemble an escalator, it now looks more like a moving pavement with a gentle upward gradient.

This reflects much weaker forecasts for private consumption, residential construction and business investment in the coming year.

Its downbeat view of the outlook for private consumption - which makes up the lion's share of the economy - mirrors its view of the housing market.

House sales remain very low and prices appear to be falling, it says. It expects a further "modest" decline (around 2 per cent) from here with some risk of a more noticeable decrease.

This is based on the observation that house price inflation has not declined as much as the drop in turnover would historically suggest it should, and on the marked decline in net immigration over the first half of the year.

The extensive revisions in the bank's view since June underline the point that its current view is only as robust as the assumptions underlying it.

One is that households, businesses and banks will remain cautious about borrowing and lending. That means, it says, that low interest rates provide less support for the economy than historically they would.

Another key assumption is that growth among trading partners will pick up again after a soft spot in the second half of this year, with the hopes pinned firmly on China and the rest of Asia (excluding Japan) and on Australia.

The other key assumption is that the coming spike in inflation from the GST rate increase and other Government policy changes will have little impact on inflation expectations over the medium term.