KEY POINTS:
Economists say the Reserve Bank will hold the line on interest rates this week, with a hoped-for easing in monetary policy still many months off.
The bank will announce on Thursday whether it will hold, raise or lower the official cash rate (OCR) from 8.25 per cent, where
it has been since July.
Economists are in no doubt the bank will leave the rate unchanged. The only question is when the drop-off will occur.
The bank has given strong signals that it will not move the rate until the risk of excessive inflation recedes. Its last forecast said it was looking to drop rates late next year.
But the market expects our faltering economy to take the pressure off inflation long before that, predicting the bank will drop the rate in October.
The bank is between a rock and a hard place - a slowing economy but unable to boost spending by cutting the OCR. To do so would fuel inflation.
Inflation accelerated in the March quarter, with the consumers' price index rising 0.7 per cent. That pushed the annual inflation rate to 3.4 per cent, up from 3.2 per cent in December and above the Reserve Bank's target band of 1 to 3 per cent.
The global price of oil was the biggest cause of annual inflation.
Westpac markets economist Sharon Zöllner, who predicts the bank will hold the interest rate until at least 2009, said the oil shocks were a central bank's nightmare because they pushed inflation up and growth down.
But while the Reserve Bank has been unlucky, with a number of shocks hitting at the same time, some say its predicament is largely of its own making.
BNZ chief economist Tony Alexander said the central bank's failure to curb inflation sooner had cut its options.
"If they had stomped harder on inflation four years ago there would now be greater scope to ease policy to fight global and building domestic economic woes," he said.
Zöllner agreed, saying the bank didn't act earlier because it assumed inflation was anchored.
"They've taken a chance on inflation when they didn't need to... Now they really need that flexibility, the ability to take a chance on inflation to support growth, because the growth outlook is now looking pretty grim for this year. But they've already spent their ammunition."
Zöllner said if the bank wanted to keep inflation within target, it needed to stay tough on the real economy. "They've basically backed themselves into a bit of a corner."
Lowering the OCR would bring down banks' borrowing costs, but there's no guarantee mortgage rates would follow.
New Zealand banks borrow overseas for about a third of the money they lend out.
Zöllner said the full impact of the credit crunch on retail lending rates was still coming.
"At the moment Australasian banks are able to get the funding they require but they are paying more for it. As more funding rolls off and has to be replaced by more expensive funding, the average cost of funding for the banks is increasing."
She warned of further hikes, even if off-shore borrowing conditions were unchanged.
