Bollard leaves rates unchanged despite worsening inflation outlook

But recent economic activity has been weaker than expected and household spending is expected to be constrained by a weakening housing market, high petrol prices and slowing employment growth, he says.

Bollard reiterated that there is no scope for an easing this year. The wholesale interest rates market obliged him by pushing out its expectations of a rate cut even further – the pricing suggests that it’s almost given up on a cut in January and starting to doubt whether there will be one by March or April.

"It really confirmed those fears that inflation really is a key issue and that the Reserve Bank was likely to be mindful of that," says Anthony Byett, chief economist at ASB Bank.

"It looks like relatively stable interest rates for the rest of the year," Byett says.

Back in March, the central bank was forecasting inflation in the year ending March 2007 would be 2.6%. Today’s statement changes that radically to 3.9%, although it is expected to fall back under 3% during 2007.

"It could be particularly ugly in the near term," says Craig Ebert, an economist at Bank of New Zealand. A big risk is whether the Reserve Bank is being too optimistic about how quickly inflation pressures will abate, he says.

Until recently, the extent of inflation pressures has been masked by factors such as the high currency and the fact that firms have squeezed margins rather than putting up prices. "You have to wonder whether the next move by firms will be to try to recoup those margins," Ebert says.

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