Inflation to hit 4 per cent but Bollard holds rates

Reserve Bank governor Alan Bollard

Reserve Bank Governor Alan Bollard left the official cash rate unchanged at 6.75 per cent today, despite the bank projecting inflation will nudge 4 per cent next year.

He said rates may have to be pushed higher if the effects of a "temporary" rise in oil prices persisted, adding that there was no prospect of a cut in rates in the foreseeable future.

The crucial decision on interest rates comes two days before Saturday's election and will come under close scrutiny.

In making his decision today, in his regular quarterly review of monetary conditions, Dr Bollard took no account of plans by both the Labour and National parties to loosen fiscal policy after the election.

"Fiscal policy is adding to uncertainty," Dr Bollard said.

While it was apparent fiscal policy would become more expansionary in the period ahead, he said the shape and economic impact of post-elections policies was "not clear at this point".

The bank based its decisions on policy as announced by Treasury and it would "not be appropriate to second-guess fiscal policy outcomes following the upcoming election".

Dr Bollard blamed the rise in oil price for pushing inflation above the bank's 1-3 per cent target band but is counting on oil returning to lower levels.

The bank is mandated to keep inflation within the 1-3 per cent band over the business cycle and the bank would not attempt to offset the unavoidable first round effects of the oil price "spike".

However, monetary policy would be used to resist any flow-through to ongoing price and wage inflation, Dr Bollard warned.

Higher oil prices would also have a dampening effect on both world and local economic activity, he said.

The bank assesses that the economy began to slow in the second half of this year, with tourism and manufacturing particularly hard hit due to the high exchange rate.

The bank forecasts economic growth in the year to March 2006 will be 2.25 per cent compared with the June forecast of 2.75 per cent. Growth is then forecast to remain around a tepid 2 per cent in 2007 and 2008.

The bank projects crude oil will fall from around US$60 ($86.48) a barrel to just above US$40 by mid-2007.

Dr Bollard said currents were tugging inflation both ways.

"Right now, it is too early to make a call on the relative strength of the emerging cross currents and how these will translate into medium-term inflation pressures."

He said it would be several months before the effects of the oil "shock" became more apparent.

A similar period could be needed for the fiscal outlook to be clarified.

"We are concerned, however, that the risk of higher medium-term inflation has increased.

"Consequently, further monetary policy tightening may still prove necessary," he said.

The bank's economic forecasts assume 90-day bank bills, which underpin mortgage lending rates, will remain at 7.25 per cent at least until the end of 2007.

The New Zealand dollar edged a little higher on the decision to US70.96c from US70.83c. New Zealand government bond yields were a couple of basis points higher.

Economists said Dr Bollard had "stuck to the script" in today's widely expected decision.

"The statement was very similar to the statements he's given previously," ANZ National Bank chief economist John McDermott said.

"(There is) no chance of any easings but (Dr Bollard) left the door open to a possible tightening."

Robin Clements, chief economist at UBS NZ said the decision showed the RB was caught between a rock and a hard place.

"They are caught... between data that has confirmed the (economic) slowdown, but on the other hand, data like the retail sales yesterday had been stronger than expected."

Inflation was likely to remain stubbornly outside of the target band for some time as the secondary effects of oil hikes flow through, he said.

- NZPA