The Reserve Bank's interest rate cut yesterday was aimed at bolstering confidence in an economy which was just starting to perk up after the best part of a year of little or no growth when it was struck by the February 22 earthquake.
But the official cash rate cut of 50 basis points to 2.5 per cent comes with a sting in its tail.
The earthquake will depress growth in the short term but when the massive task of rebuilding Christchurch gets under way in the new year it will put upward pressure on inflation.
Interest rates will inevitably rise again - later, but more steeply.
"We expect that the current monetary policy accommodation will need to be removed once the rebuilding phase materialises. This will take some time," the bank said in a hastily rewritten monetary policy statement.
"Because reconstruction is likely to take many years, this inflation impulse could prove persistent ... It would therefore be inappropriate for monetary policy to be stimulatory during reconstruction."
Governor Alan Bollard told MPs on the finance and expenditure committee the earthquake would cut growth by 1 or 1.5 per cent this year but the rebuilding activity required would boost it by about 2.5 per cent next year.
The bank's projections, which it cautions need to be taken with more than the usual grain of salt, have short-term interest rates by the end of next year back where it expected them to be in its forecasts three months ago. A lower track this year implies a steeper tightening next year.
The OCR cut was more aggressive than financial markets had expected, prompting a drop in the dollar and short-term interest rates. "We thought there was no point in mucking around [with a 25-point cut]," Bollard told the MPs.
The interest rate decision was not just a response to the earthquake, however. The economy had ended 2010 significantly weaker than the bank had expected.
It is not sure there was any growth in the December quarter, when three months ago it had forecast 0.4 per cent. For the whole of 2010 it thinks the economy grew just 0.5 per cent (the official number is still two weeks away) as households reined in consumption and businesses deferred investment. The bank expects the earthquake will cut GDP in the current quarter by 0.6 per cent, which would be enough to tip it just into contraction territory.
It reckons the amount of spare capacity in the economy is similar to the depths of the 2008/09 recession and underlying inflation pressure is correspondingly weak.
It will ignore the immediate inflationary impact of the quake on rents and insurance payments. Coming on top of the GST rate increase and rising food and oil prices, it is expecting to see the annual inflation rate spike to 5.4 per cent by June.
But the bank sees inflation then falling back to around the middle of its 1 to 3 per cent range by next year.
Private sector economists regard that as too optimistic.
Higher construction costs on top of the higher energy and food prices could easily see inflation settling towards the top of the target band, said ANZ chief economist Cameron Bagrie. "[But] for now inflation is not a predominant concern for the Reserve Bank, with the focus more on ensuring that the economy remains supported in the near term."
BNZ economist Stephen Toplis said the Reserve Bank had decided it needed to ensure there was no collapse of confidence in the economy.
"We understand that and are not critical of the decision. However we take the view that it probably won't make much difference and is misdirected. Most of those who gain from it are not those who lose from the quake."
The economy was starting to show signs of significant improvement, Toplis said. The property market was stabilising with the terms of trade the best for nearly 40 years.
"The earthquake does not reset everything. How many farmers are affected by it? And Business New Zealand tells us the vast majority of the manufacturing sector in Christchurch is capable of operating at full capacity."