A speech by the Reserve Bank's assistant governor and chief economist John McDermott yesterday gives support to market expectations that the next move in interest rates is likely to be down.
"The outlook for inflation is subdued, and suggests that monetary policy should remain stimulatory for a prolonged period," McDermott said.
The bank was not considering any increase in interest rates whereas "evidence of weakening demand and domestic inflationary pressures would prompt us to consider lowering interest rates".
Speaking to the Herald after his speech to a Hamilton business audience, McDermott said there had clearly been a shift from the neutral "either up or down" guidance in last month's monetary policy statement.
"We still need more evidence to shift downwards," he said.
"We are sort of happy with where we are at the moment.
"We think monetary policy is still stimulatory. But given the starting point the risk is that something weaker could pop up and that would be very material."
Inflation was just 0.1 per cent in the year ended March and even if the transitory effects of lower oil prices are discounted, it would still have been at or just below the 1 per cent bottom of the bank's target band.
The bank believes that economic growth is running faster than it can sustain long-term, based on fundamental supply-side factors like labour force growth, business investment and technology.
But excess demand is needed to deliver the bank's inflation target, hence the prospect of a prolonged period of stimulatory monetary policy.
Factors the bank is watching which could weaken demand and inflationary pressures include low export dairy prices, the lingering effects of the drought, and the impact of the "unwelcome" strength of the New Zealand dollar on exporting and import-competing industries.
The high dollar also makes it harder for the bank to achieve its inflation target by reducing the cost of imported goods, adding to the disinflationary impact of excess capacity and weak commodity prices in the global economy.
Those "massive" cyclical factors outweighed any structural influences, from globalisation or technological change, that could be keeping prices low, McDermott said.
The Reserve Bank is also wary of the downward trend in inflation expectations.
"The bank remains vigilant in watching wage bargaining and price-setting outcomes.
"Should these settle at levels lower than our target range for inflation, it would be appropriate to ease policy."
BNZ economist Craig Ebert said: "So it'll be important to watch the wage and salary data, and the various business pricing and inflation expectations variables, like a hawk. Or, should we say, like a dove?"
Deutsche Bank chief economist Darren Gibbs took McDermott's speech to simply acknowledge that with inflation close to zero the only plausible change in the official cash rate in the near term is a reduction.
"In that sense one could characterise the Reserve Bank as having a very soft easing bias.
"Certainly we think it is happy to be characterised as having such a bias to the extent that this helps jawbone down the New Zealand dollar," Gibbs said.
"However, we think that domestic economic conditions, including in the housing market, will continue to rule out a lower OCR as a sensible policy option."
ASB chief economist Nick Tuffley puts around a 25 per cent probability on an OCR cut this year.
• Low export dairy prices
• Lingering effects of the drought
• Impact of strength of the NZ dollar