KEY POINTS:
There has been good news and bad news for Reserve Bank Governor Alan Bollard this week in his war on inflation.
The good news is likely to carry more weight.
Yesterday's December quarter inflation data was better than expected but the Institute of Economic Research's quarterly survey of business opinion (QSBO) on Tuesday pointed to serious inflation risks on the medium-term horizon.
In principle the latter should weigh more in the bank's counsels - because of the time it takes monetary policy to work, its eyes should be on the medium-term horizon.
But Bollard's natural preference, and arguably his mandate, is to give growth a go.
So at the moment it looks likely he will leave the official cash rate on hold at the next review next Thursday, buff up the cautionary rhetoric and hope for the best.
It was no surprise that lower petrol prices have brought annual consumers price index inflation back within the bank's 1 to 3 per cent target band after 18 months outside it.
It fell to 2.6 per cent from 3.5 per cent in September.
Without a 15 per cent fall in petrol prices the CPI would have risen 0.6 per cent in the December quarter instead of the 0.2 per cent fall which goes into the record books. Even better, inflation in the non-tradeables sector, the part of the economy which is supposed to be influenced by interest rates rather than the exchange rate and international prices, has eased somewhat.
It was 0.8 per cent for the December quarter, making 3.8 per cent for the year.
It is the lowest rate for more than three years and suggests that monetary policy may at last be getting some traction in the domestic economy.
If so it has been a long time coming. Bollard started tightening three years ago and the annual rate of non-tradeables inflation has declined by less than a percentage point from its peak of 4.7 per cent 2 years ago.
His concern now must be whether that trend will continue when the economy is gathering steam again and when, as the QSBO showed, there are still significant capacity constraints on the supply side.
True, the net balance of firms saying they intend to increase investment in plant and machinery was the highest for 12 years. If they follow through that will boost productive capacity and relieve inflationary bottlenecks,
But they haven't done it yet and right now the level of capacity utilisation remains high by historical standards.
And the labour market has tightened. For a year or so firms had been reporting it was getting easier to find skilled labour. Now they say it is getting harder again.
Hiring intentions are up, and this from a starting point of 3.8 per cent unemployment.
The structural tightness of the labour market has been one of the features of the downturn. With firms hoarding labour and job security high it has been hard for Bollard to get the household sector's attention.
At the same time low interest rates abroad have made lending to the New Zealand banking system an attractive proposition for foreign savers, allowing the banks to offer fixed-rate mortgages at rates home buyers have been happy to pay, pretty much regardless of the official cash rate.
Those two things have meant that, to put it crudely, while Bollard wagged an admonishing finger at the household sector, it wagged two fingers back.
Even the decline in petrol prices, which has brought some short-term relief on the inflation front, has a sting in its tail from Bollard's point of view.
The less people need to spend at the petrol pump the more they have to spend on other things.
For a central bank that is counting on consumer spending growth slowing to almost zero over the next couple of years, that is unhelpful.
Since the New Year, oil prices have continued to fall, to an 20-month low. But it can't continue indefinitely. You don't have to direct your gaze for very long at the Gulf to imagine any number of scenarios under which that region is once again the epicentre of a global oil shock.
The disinflation in the tradeables sector was largely but not wholly due to lower oil prices. The high dollar also had an impact, pushing down the costs of other imported goods.
In this cycle it is mainly through the exchange rate, and business borrowing costs, that the monetary tightening has worked.
The QSBO does not cover the agricultural sector. If it did, business sentiment might be registering something less than the four-year highs recorded in Tuesday's report, even with reasonable world prices for agricultural export commodities providing a degree of offset to the exchange rate.
Remarkably, manufacturers on balance expect some increase in exports, but only just (a net 2 per cent) and less so than in September (a net 6 per cent).
Wariness of pushing the currency higher still will undoubtedly be a major factor in Bollard's thinking when he decides whether to hike the official cash rate next Thursday.
It is telling that he did not hike in December, when the financial markets had persuaded themselves he might well do so and would not have reacted adversely if he had.
The bank's economists had written him a very hawkish monetary policy statement. In effect they loaded the pistol, cocked it and handed it to him, but he put it in his holster without pulling the trigger.
Now, with annual GDP growth at a feeble 1.4 per cent, inflation back to 2.6 per cent, and the dollar at US69c, a further tightening of the monetary screws would be hard to sell.
The risk he runs by sitting tight is that the steep fall in tradeables inflation will go into reverse, if world oil prices rebound or the dollar drops or both, while inflation on the non-tradeables side remains high.
