KEY POINTS:
There is no joy for households in the Reserve Bank's latest forecasts.
They see interest rates staying at their current high levels until the second half of 2009, with inflation above 3 per cent through next year and declining slowly from there.
Household spending next year and the year after is expected to be the weakest it has been since 2001.
Two-year fixed mortgage rates are already the highest they have been for nine years.
About a quarter of all mortgage debt comes up for an interest rate reset over the year ahead. If current mortgage rates stick, those borrowers face increases of 0.7 to 1.5 percentage points, the bank says.
And with world financial markets in the grip of a credit crunch, driving up the risk premium in interest rates, there is little prospect of relief for borrowers from that quarter.
The Reserve Bank - which left the official cash rate at 8.25 per cent yesterday - acknowledges in its monetary policy statement that the international environment could turn ugly. But Bank of New Zealand economist Stephen Toplis said it had to balance that uncertainty against things that are certain, like higher food and much higher oil prices, a tight labour market, strong export dairy prices and virtual certainty of tax cuts.
In such circumstances the bank's tightening bias - indicating that any change in the official cash rate is more likely to go up than down - was entirely appropriate, he said.
ANZ National bank chief economist Cameron Bagrie said the Reserve Bank had backed itself into a corner on inflation. The big unknown was how much the United States economy would slow as the credit crunch spreads from Wall Street to Main Street, and then how much China and other East Asian economies could maintain their momentum.
"If the 'decoupling' thesis [that world growth is less reliant on the US consumer than it used to be] holds, commodity prices will remain strong and the Reserve Bank will still have a real inflationary problem. If it doesn't, inflationary pressures will dissipate," Bagrie said.
The Reserve Bank has revised its economic growth forecasts down and its inflation forecast up - to a peak of 3.5 per cent next year.
But Westpac chief economist Brendan O'Donovan expects it to go to 3.9 per cent.
The Reserve Bank acknowledges the potential inflationary impact of the Government's planned emissions trading scheme, which will increase petrol prices from 2009 and electricity prices the following year.
But it has not put them into its forecasts on the ground that it is too hard to estimate what the carbon price will be and on the ground that it should only react to "second round" impacts as people raise their inflation expectations and seek to pass the increased costs on.
"We agree the impact is very uncertain but it is most certainly not going to be zero," O'Donovan said.
While the Reserve Bank cites higher oil prices as the single biggest reason for a higher inflation forecast next year, it also assumes that international oil prices will decline.
But when Governor Alan Bollard appeared before the finance select committee, Greens co-leader Jeanette Fitzsimons presented him with a graph plotting similar assumptions about oil prices from previous monetary policy statements - all based on international consensus forecasts and all confounded by events.
Over the past three years inflation has been above the top of the bank's 1 to 3 per cent target band for half of the time, and the bank forecasts it to be above 3 per cent through next year and to average 2.9 per cent through the first half of 2009.
Toplis said the bank had looked like it was happy with inflation just under 3 per cent. "We found this discomforting and suggested the bank should do something to disavow this perception."
Yesterday it did so, saying that under normal circumstances it would expect to have inflation on average closer to the mid-point of the target band over the course of the entire cycle. "Three cheers for the rhetoric," Toplis said. "Now we await the supporting action."
Forecasts
* Higher inflation - more than 3 per cent through next year and still in the top quartile of its target band through 2009.
* Weaker growth but still above 2 per cent through the next two years.
* Consumer spending weakens to its softest pace since 2001 even with a dairy boom and tax cuts.
* Interest rates stay around their current cyclical highs until well into 2009, while the dollar stays above 70 on the trade-weighted index.
* But wage growth moderates and productivity improves.
