KEY POINTS:
Reserve Bank-watchers see no chance at all that Governor Alan Bollard will cut the official cash rate from 8.25 per cent on Thursday.
Instead they will scrutinise the language of the March monetary policy statement, and the forecasts it contains, for signs that he may ease back on the brakes later this year.
Since the bank's December statement some things have been going its way.
The cooling of the housing market - something the bank has been trying to engineer for several years - is proceeding if anything faster than the bank expected, driven not only by higher interest rates but also by a drying up of net immigration.
Associated with that, consumer spending has been going sideways.
"Over the past few years household spending has proven incredibly resilient to higher interest rates and growing costs," ASB chief economist Nick Tuffley said.
"However there is always a last straw on the camel's back. Recent fuel and food price rises, and higher mortgage funding costs due to the global credit crunch, are all candidates."
The global credit squeeze has been driving up retail interest rates without the Governor having to lift a finger, by widening the risk premium built into rates.
Fixed mortgage rates were between 30 and 50 basis points higher than when the Reserve Bank raised the OCR to 8.25 per cent last July, Deutsche Bank chief economist Darren Gibbs said.
That increased the "pipeline" effect as loans taken out at the much lower rates prevailing two years ago come up for an interest rate reset.
"While we don't expect a genuine easing cycle to begin before year end, we do think it is worth considering the possibility that the Reserve Bank might at some stage undertake a one-off 'recalibration' [lower] of the OCR to effectively remove the impact of the additional tightening which has transmitted ... due to developments in the credit markets."
Meanwhile the outward-facing sectors of the economy are caught between weakening world growth and a strengthening kiwi dollar.
The exchange rate has continued to rise, and not just against the enfeebled US dollar. On a trade-weighted basis the dollar yesterday was trading 2 per cent higher than the bank has assumed for this year.
Consensus forecasts for growth among our trading partners have been slashed by more than a third of a percentage point since December.
Dry conditions, amounting to outright drought in some parts of the country, will take the cream off the expected dairy payout bonanza this year.
"Fortunately the worst of the drought struck after the peak of the season had already passed - three-quarters of production is over by the end of January," Westpac chief economist Brendan O'Donovan said.
"The drought could knock $400 million off our earlier forecast of a $4.1 billion increase in the total payout this season. And it will probably knock $750 million off total farm incomes [including sheep and beef farmers]."
Businesses' views of their own prospects are the weakest they have been for two years, the National Bank's February survey found.
But inflation at 3.2 per cent is already outside the bank's 1 to 3 per cent target range and it is forecast to go higher.
The international environment holds no prospect for relief. Inflation among developed countries is running at 3.3 per cent, underpinned by high oil and food prices.
In China, which for years was a disinflationary influence, it is running at more than twice that rate.
At home there is little spare capacity in the economy.
Even after two years of below-trend economic growth, the unemployment rate is a historically low 3.4 per cent.
And the manufacturing and construction sectors report historically high levels of utilisation of plant and equipment.
The bank has yet to formally include the effects of the emissions trading scheme on transport fuels from the start of next year and electricity a year later.
But it has indicated it expects the cumulative effect will be to raise the consumer price index by 0.6 per cent over the next two years, even at a rather conservative estimated carbon price of $21 a tonne.
The outlook for the economy is on a knife edge, ASB's Tuffley said.
"We could conceive of a scenario in which the Reserve Bank cut rates as early as the September quarter ... But to bring about imminent cuts to the official cash rate, the economic outlook would have to turn very nasty for inflation to drop quickly even to the mid-point of the target band."
IN THE SCALES
Alan Bollard will weigh:
* The domestic economy decelerating.
* The international outlook darkening.
* Drought.
Against:
* The certainty of tax cuts.
* The risk of of wage-price spiral.
* The impact of emissions trading.
