Market perceives that Bollard softens the rhetoric

Reserve Bank governor Alan Bollard left interest rates unchanged as expected, acknowledging the weakening economy but saying short-term inflation pressures remain persistently high.

Thursday, April 24th 2008, 12:00AM

by The Landlord

By Jenny Ruth

"We see significant downside risk to future activity but upside risks to inflation," Bollard said.

Nevertheless, economists and financial markets interpreted the statement as softening the rhetoric, particularly because Bollard said only that his official cash rate (OCR) "will need to remain at current levels for a time yet," a notch down from the phrase "a significant time" used in March.

"One word can make all the difference. They're unlikely to have omitted that by accident," says Nick Tuffley, chief economist at ASB Bank.

The Reserve Bank's growth forecasts in March were quite optimistic compared to where the consensus forecasts of other economists have shifted down to and its next forecasts due in June are likely to show significantly lower growth, Tuffley says.

But on the inflation front, Bollard was "quite pointed in focusing on the potential for wage inflation to be bumped up," he says. Bollard said there's a risk wage settlements respond to short-term price shocks, perpetuating inflation pressures.

Westpac chief economist Brendan O'Donovan says the omission of the word "significant" was sufficient for financial markets to sell the current down a bit over a quarter of a US cent and push interest rates down about eight points.

"The symantics of these things get very important," O'Donovan says. "For a time yet" means it's unlikely the central bank will cut rates in six weeks time but still brings the cut forward from previous indications.

O'Donovan says this is a risky strategy. "It sets the market up to respond more to weak growth prints than higher inflation," he says.

While in the past inflation pressures have subsided as the economy slowed, we're now in a "cost-plus inflation environment," he says.

« The official cash rate (OCR) will remain unchanged at 8.25%.OCR unchanged, but coming down sooner than expected »

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