KEY POINTS:
Reserve Bank Governor Alan Bollard is expected to leave interest rates on hold on Thursday, but the accompanying statement is likely to stress that we are not yet out of the inflationary woods.
The fresh information the bank has had since its December monetary policy statement has weighed on both sides of the scales.
Most market economists believe Bollard will not change the official cash rate on Thursday, and the money markets see only a one-in-three chance of a hike, according to Credit Suisse's swaps-based indicator.
The December statement had another hike in the OCR, from the current 7.25 per cent, built into its forecasts and Bollard made it clear it would be the strength of the housing market more than anything else which would determine whether he followed through.
On Friday the Real Estate Institute reported that the national median house price was unchanged in December at $330,000, holding on to the gains of recent months and up a hefty 11.9 per cent on a year ago.
Deutsche Bank chief economist Darren Gibbs said when adjusted for seasonal effects the number of house sales last month was up 8 per cent on November. When allowance was made for growth in the number of households, turnover was running 19 per cent ahead of the historical average.
The housing market is underpinned by a robust net inflow of migrants and by a labour market which remains tight and which, if the hiring intentions recorded in last week's NZIER quarterly survey of business opinion are anything to go by, is set to get tighter still.
Meanwhile, the same fall in petrol prices which underpinned a drop in inflation to 2.6 per cent in the December quarter will also boost consumers' discretionary spending power, putting upwards pressure on inflation.
But there have been helpful developments too:
* The exchange rate is higher than the central bank assumed it would be. This has a braking effect on the economy, felt first in rural regions, where business confidence and consumer spending are already notably weaker than in Auckland.
* International interest rates have moved in a direction which reinforces rather than undermines what Bollard is trying to do. Higher world rates have pushed up the interest rates on offer for fixed-rate mortgages all along the curve leaving no room for new borrowers and those whose fixed mortgages have come up for reset to hide.
* Economic growth in the September quarter, at 0.3 per cent, turned out weaker than expected. In addition, previous quarters were revised down.
Even though economic activity has accelerated since then, it means that all else being equal there is more slack in the economy than the bank had thought, buying time before capacity constraints bite.
* The December quarter inflation data was also benign. The drop in the headline rate to 2.6 per cent from 3.5 per cent three months ago and the prospect of a rate of 1.5 per cent or lower by mid-year should lower inflation expectations and reduce the pressure for compensatory wage increases.
While much of the fall was due to lower petrol prices, inflation excluding energy prices also fell, to 2.7 from 2.8 per cent.
Non-tradeables' inflation fell to 0.8 per cent in the December quarter, after two years of quarterly increases of 1 per cent or more. The trimmed mean measure also eased to 3 per cent from 3.4 per cent in September.
Though these movements are in the right direction, the levels are still high in the Reserve Bank's view and the factors underpinning the decline - anaemic economic growth, a high exchange rate and falling world oil rises - cannot be expected to continue indefinitely.
Bollard has also fretted about the prospect of increased stimulus to demand in the economy from the Government's fiscal policy - through increased spending or tax relief.
Gibbs argues that if Bollard sits tight he risks maintaining a mix of monetary conditions that keeps the economy badly off balance. The continuing strength of the housing market showed borrowers did not regard interest rates as too high, he said, while exporters and firms competing with imports had to cope with an overvalued exchange rate.
It was expectations for future interest rates, rather than the current rate, which mattered most for the exchange rate. Gibbs said: "The sooner a plausible easing scenario comes on the horizon, the sooner the exchange rate will correct lower."
Weighing in
* Falling oil prices and the high dollar have bought the Reserve Bank some time.
* But the medium term inflation outlook is still menacing.
* Financial markets expect another interest rate hike some time this year.
