KEY POINTS:
Turmoil on international credit markets is likely to loom large in this week's monetary policy statement from the Reserve Bank, economists say.
Economists are expecting the central bank to keep its official cash rate steady at 8.25 per cent come Thursday, and for governor Alan Bollard to maintain the same stern line on inflation as he did in the last announcement on July 26. But a lot has happened since then.
Firstly, the uncertain state of the risky US sub-prime credit markets has sent shockwaves around the financial world.
US mortgage defaults are soaring and credit markets have come close to seizing up as lenders grow reluctant to lend.
Secondly, the NZ dollar, which the bank spoke of as being unsustainably high back in July, has since fallen away dramatically. It traded on Friday at US$0.6924 Friday, compared with its July average of US$0.7858.
Thirdly, and less significantly, more New Zealand finance companies have gone to the wall.
ASB Bank treasury economist Daniel Wills said he expected the central bank to acknowledge that international credit concerns did exist and he expected the bank to take a wait-and-see approach on global credit issues.
He said the improved export outlook in New Zealand was helping to offset those global credit market concerns, assisted in no small part by the big fall in the New Zealand dollar.
"But obviously with the New Zealand dollar falling, that just adds to the inflation risks that they are facing - both externally generated inflation as well as still relatively robust domestic inflation," said Wills.
Wills and other economists expected the Consumers Price Index, which rose 2.0 per cent in the year to June, to remain towards the top end of the Reserve Bank's 1.0 to 3.0 per cent target range towards the end of 2008, which meant high mortgage rates would be around for a some time yet.
Wills said the fall in the New Zealand dollar was a double edged-sword - it had brought some relief to exporters but had increased the inflation risks from externally generated inflation.
Sharon McCaw, markets economist at Westpac Institutional Bank, said that despite the likelihood of more of the same from the Reserve Bank, its statement would be keenly watched because of the ructions on world markets.
She said the inflation picture remained "ugly" and suggested that the bank would have been tempted to hike rates again if circumstances were more normal.
"We think they will want to talk pretty tough in the meantime, but that said we think they will want to reassure markets that they are monitoring the situation closely and that they stand ready to take action with monetary policy if it looks like there will be damage to the real economy," said McCaw.
But as far as the woes of local finance companies are concerned, McCaw expected the bank to be "fairly sanguine" about the impact those failures would have on the economy.
Deutsche Bank NZ said it expected the Reserve Bank to show some satisfaction with the slowdown that was occurring in the housing market.
"But the bank will also note that strong trading partner growth, record commodity prices, and expansionary fiscal policy have the potential to sustain inflation pressures," Deutsche Bank said in a research note.
