Alan Bollard's forecasts are based on some key assumptions. Photo / Mark Mitchell
At first glance the Reserve Bank presents an upbeat view of the outlook in its June monetary policy statement.
It sees a broader-based recovery under way which will deliver annual average growth of 3.5 per cent in the year to next March and 3.6 per cent the year after.
The
rise in inflation driven by GST and other Government charges is seen as a short-lived blip, and the unemployment rate is expected to be back down below 5 per cent by early 2012.
But the forecasts also contain some more downbeat numbers.
Business investment is expected to rise, eventually, from its current depressed levels but to remain, even three years out, below its average level over the past decade, relative to the size of the economy.
That is seen as a consequence of the global rise in interest rates to which New Zealand, heavily reliant as it is on imported savings, is exposed.
Reflecting constrained capital investment, the economy's potential growth rate - the rate at which its productive capacity grows - remains stuck around 2 per cent over the next three years. Actual growth is stronger than that for a while because of the spare capacity built during the recession.
It is a much weaker potential growth rate than the 3 per cent or more in the upswing of the last cycle and it implies that inflation pressures could emerge earlier than in previous cycles.
A key assumption underpinning the bank's forecasts is that the inflation rise in the year ahead - to a peak of 5.3 per cent, it estimates - will have a limited medium-term effect on inflation expectations.
Governor Alan Bollard said he was taking a "fairly benign" view of that risk at this stage. People would see the effects of the GST rise and other Government policy changes pushing up the cost of living for what they are, one-offs. In particular the GST rise is not expected to affect wage bargaining, as it should be more than offset by income tax cuts.
But even if Bollard's confidence is vindicated, the bank's projections still have inflation running in the top quarter of his 1 to 3 per cent target band once the spike in inflation washes out of the numbers. This implies little headroom to accommodate any unexpected upward pressure on inflation.
Another assumption underpinning the bank's forecasts is that growth among New Zealand's trading partners remains robust.
But Bank of New Zealand economist Stephen Toplis is less sanguine.
"It is not so much that we fear a European implosion, which looks more and more a given, but rather we are concerned that tightening fiscal and monetary policy in China could slow the Asian region down more than anticipated."
The third key assumption is that households and businesses (including farmers enjoying record commodity prices) continue to reduce debt. Credit growth has been feeble. But it could be just a typical cyclical response to a recession.
See the text of Governor Alan Bollard's statement here.
See the full Monetary Policy Statement here.
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