Financial markets see it as a line-ball call whether Reserve Bank Governor Graeme Wheeler cuts the official cash rate from 3.5 to 3.25 per cent on Thursday.
"The interest rate market has now priced a 50:50 chance of a 25 basis points rate cut in June, and a 100 per cent probability of a rate cut by July," ASB chief economist Nick Tuffley said. "A full 50 points - two cuts - is priced in over the next seven or eight months. "
Tuffley expects Wheeler to wait until September to cut but in the meantime to explicitly forecast a cut in this week's monetary policy statement.
Since the last rates decision in April events had largely pointed to inflation pressures being weaker than the Reserve Bank envisaged, he said.
Strong net immigration and high labour force participation meant more slack in the labour market than the bank had assumed, while further falls in export dairy prices and Fonterra's opening forecast for the new season suggested farmers would remain cautious with spending.
Business confidence slumped in the most recent ANZ survey. However, consumer spending and population growth remained very strong and the housing rebound has spread beyond Auckland, Tuffley said.
"And inflation expectations have lifted in response to the rebound in petrol prices, reducing for now concerns that low inflation could impact wage- and price-setting behaviour."
The New Zealand dollar has fallen five cents against the US dollar since the April review and on a trade-weighted basis is 2.7 per cent lower than the bank assumed it would be in its March forecasts, weakening one of the factors keeping tradables inflation negative.
"However the dollar's weakness is in part due to growing expectations of a rate cut and will only be materially sustained if the Reserve Bank follows though at some point." An on-hold decision on Thursday would trigger a spike in the kiwi dollar and wholesale interest rates but it would be temporary, Tuffley said.
Capital Economics' chief Australia and New Zealand economist Paul Dales is also not convinced the Reserve Bank is ready to start reversing last year's rate hikes yet. "In recent years the Reserve Bank has always embarked on a series of interest rate moves after it has stated its intention [to do so]. That requires something more explicit than the loosening bias adopted in April," he said.
Wheeler said then that a lower OCR would be appropriate if demand weakened or if wage- and price-setting outcomes settled at levels lower than is consistent with the inflation target.
Retail sales climbed 2.7 per cent in real terms during the first three months of the year, the strongest performance for eight years. In Auckland core retail sales were up 9.7 per cent in nominal terms on a year earlier, a period when the consumers price index rose just 0.1 per cent.
ANZ is among the minority of forecasters - three out of 15 in the latest Reuters survey - who believe Wheeler will cut the OCR on Thursday (and again next month).
Economic growth was easing towards trend rates and the risk profile had worsened, ANZ economist Mark Smith said, while inflation had failed to materialise when growth was strong.
"Annual CPI inflation is at a 15-year low and core inflation has been below 2 per cent for 21 consecutive quarters," he said.
Inflation expectations sit below the inflation target mid-point of 2 per cent when they normally sit above it given the surveys' biases.
This raised the question where inflation could be if growth slipped below trend, which was an emerging risk, Smith said.
The economy needed a lower New Zealand dollar as a release valve and the only way to get it lower in a concerted trade-weighted manner was to cut the OCR, he said.