KEY POINTS:
This morning's interest rate decision may be the toughest call Alan Bollard has had to make in nearly five years as Governor of the Reserve Bank.
The money markets see the odds as two-to-one that he will raise the official cash rate to 8.25 per cent.
If he disappoints them, he risks triggering a drop in wholesale interest rates including those that banks base fixed-rate mortgages on.
As cooling the housing market remains the key to getting inflation under control, he will be reluctant to do that.
But the dollar is at stratospheric heights, in part because of high interest rates, and exporters are hurting.
So if he raises the OCR, Dr Bollard can expect to be accused of knee-capping exporters and destroying jobs.
Finance Minister Michael Cullen has thrown a new, political consideration into the mix.
By pointedly reminding everybody last week of a long-forgotten power the Government has to change the rules that govern interest rate decisions, he has raised questions about the bank's independence and whether combating inflation will remain its overriding concern.
Prime Minister Helen Clark has hosed down such speculation since her return from Indonesia at the weekend.
But Dr Bollard might still feel he now needs to demonstrate his independence and reaffirm a single-minded focus on inflation by raising the OCR.
If he raises the OCR, floating mortgage rates will go up. But these days they only account for about 13 per cent of all mortgage debt.
Westpac chief economist Brendan O'Donovan said fixed-rate home loans were likely to rise too, between 0.1 and 0.15 percentage points for one to three-year terms. Business borrowing costs would also rise, but not credit card rates which are a lot less sensitive to the OCR.
The financial markets watch all the same economic data that the RBNZ does and spend a lot of time trying to second guess the bank.
Up until two weeks ago, they thought Dr Bollard was likely to think the three interest rate increases since March might be enough and he would go into wait-and-see mode and put rates on hold today.
But since then, stronger-than-expected retail sales in May and inflation in the June quarter have strengthened the case for another rate increase, even as the higher dollar has reduced it.
"If he hikes, there will be some upward pressure on the currency, but probably shortlived," Mr O'Donovan said.
"It's the trend that is dominating the exchange rate rather than the interest rate decision. A fair chunk of it is US dollar weakness."
Dr Cullen's comments had been extremely unhelpful. "Kite-flying is better on a calm day than when it is stormy."
Mr O'Donovan said that if Dr Bollard did not raise the OCR there would be a drop in wholesale interest rates. The market would second guess the Governor's rationale, not knowing if his reasons were economic or political.
At 8 per cent, the OCR is already twice as high as the average of the equivalent interest rates among the major industrialised economies. Australia's OCR is 6.25 per cent.
Mr O'Donovan said the RBNZ could not set one interest rate for the export sector and one for the domestic parts of the economy. "What they said in June was right. The only way they can get the exchange rate down is to get on top of domestic inflationary pressure," he said.
"But for Dr Bollard this is one of those days when whatever you are paid isn't enough."
