Brian Fallow: Judgment day can't be far off

The Reserve Bank expects the inflation rate to come back down below 3 per cent in the September quarter.

Unfortunately, that's the September quarter next year.

By then, inflation will have been outside the bank's target zone of 1 to 3 per cent for at least two years.

No wonder Governor Alan Bollard now has a real problem with inflation expectations and feels the need to fire off warning shots about "extravagant" wage settlements or price increases.

Which raises the question of how long inflation can be outside the target zone before he is in breach of his contract with the Government and his job is on the line.

When asked about this yesterday by journalists and MPs, his response was rehearsed but absurd.

"The policy targets agreement, of course, talks about keeping the future CPI projected track within the 1 to 3 per cent range on average over the medium term. We have got a picture now of inflation staying outside that 1 to 3 per cent zone for, I guess, a bit more than a year, but less than two years," he said. "In our view, that is consistent with the policy targets agreement. In addition, the PTA does talk about avoiding unnecessary instability in exchange rates, interest rates and output."

It can't be right that the governor's performance is always to be measured by the future outlook for inflation.

The future continually turns into the past and, at some point, he has to be judged by his record.

True, he has been faced with an oil shock. Nearly half of the whopping 1.4 per cent jump in the bank's inflation forecast for the year ahead is blamed on oil. If you take petrol out, inflation over the past three quarters would have been a more respectable 2.6 per cent or so. But the bank's own projections have even CPI inflation excluding petrol climbing above 3 per cent.

And its overall inflation projection by the end of 2008 - when current monetary policy will be having its effect - is still 2.5 per cent. That suggests the bank is not aiming for the middle of its target band but for the top quartile.

So how long is the "medium term"?

Bollard has been careful not to paint himself into a corner on that. He said it depended on the circumstances - but in normal circumstances about three years.

People's confidence that we still have a low inflation environment can handle spikes in CPI inflation such as we saw at the end of 2000.

But that looked like Mitre Peak. This one looks more like Ayers Rock.

Bollard is between that rock and a hard place and that's bad news for borrowers.