Brian Fallow: Sticky times await Governor

Governor Alan Bollard is in a sticky position, as sticky as heavy crude oil.

The Reserve Bank's forecasts have inflation nudging 4 per cent in the first half of next year and not falling back below the top of the target band, 3 per cent, until 2007 and even that depends on a whole lot of things going right.

One is that the oil price will stay around present levels for the rest of the year, then track down towards US$40 a barrel by the end of 2007.

But there is a lot of uncertainty about that; international analysts are offering an especially wide range of forecasts these days.

Another key assumption is that the kiwi dollar, which is keeping a lid on the cost of imported goods, will head back down but not too quickly. Forecasts of the dollar's track are notoriously unreliable.

Bollard is also relying on high petrol prices not spilling over into generalised and persistent inflation, despite a tight labour market and other pressures on profit margins.

He is relying on growth in consumer spending dwindling to almost nothing over the next couple of years but, as BNZ economist Stephen Toplis says, that will require household spending to be the softest it has been since the recession of 1991 despite rising wages, low unemployment and either tax cuts from National or increased family support from Labour.

It must have been hard for Bollard to write the monetary policy statement with all fingers crossed.

If all that goes to plan, inflation will still have been outside the target band for around 18 months.

Will that erode confidence in the hard-won low-inflation environment? A brief spike in the CPI to 4 per cent in 2000 did not, but conditions were different then.

Yesterday, Bollard conceded that there was evidence of inflation expectations moving up "slightly but not markedly".

He might consider himself unlucky that an oil shock came along at the time when the pent-up inflation from years of above average growth was at its peak.

And he might take comfort in the fact that he has a more liberal mandate than his predecessor. The governor's employment contract, the policy targets agreement, requires him to keep inflation in the 1 to 3 per cent range "on average over the medium term".

How long is that? "We might interpret that as around three years, but we have been pretty clear it would depend on the circumstances. It was never meant to be a mechanical test," he said.

He is cutting it fine.