KEY POINTS:
The Reserve Bank is expected to leave its official cash rate (OCR) unchanged this week, but resurgent oil and food prices mean it is likely to be sensitive to inflation expectations.
Market economists agree the chance of a change in the rate, which sits at 8.25 per cent,
coming from Thursday's monetary policy statement (MPS) is nil.
The question is, when will the rate go into retreat? Most economists expect the bank to start easing in mid- to late-2008, with some saying early 2009.
"We predict the OCR to be held steady at the December MPS and January review, but to be raised by 25 basis points in the March 2008 statement, with a further hike to follow," says Westpac's chief economist, Brendan O'Donovan.
Oil and food price rises are likely to feature strongly in the Reserve Bank's thinking, particularly because of the part they are likely to play in forming people's inflation expectations.
The danger is that those expectations can themselves prove inflationary as price setters raise their prices in anticipation of costs being higher.
ASB Bank chief economist Nick Tuffley says there remains sufficient uncertainty on the inflation front for the central bank to leave the rate where it is.
He says the Reserve Bank will, however, take some heart from the fact that the housing market is starting to respond to higher interest rates, and consumer spending is moderating.
There is also the prospect of a greater "pipeline" effect of fixed interest mortgages rolling off into the new, higher interest rate environment. While inflation in the year to September was just 1.8 per cent, the consumers price index is expected to escalate.
Tuffley says it is conceivable food and oil prices may bring inflation to 3.5 per cent next year. There are concerns about the tight labour market and higher wages contributing to the overall inflation picture.
"The Reserve Bank will be worried that inflation expectations will start to take off again, with all the potential impact that has for our behaviour as individuals and businesses," Tuffley says. "What we expect could become reality, so they will be worried about that risk."
Economists say, however, the present turmoil on credit markets may act to deliver lower rates sooner than expected if it hits the US economy hard.
"Most people are getting worried about what is happening in the United States," says Tuffley. "We have heard the squealing of tortured rubber, but what we haven't really seen yet is any impact from the accident itself."
Deutsche Bank NZ chief economist Darren Gibbs expects a similar message from the Reserve Bank as outlined in September and October. Those statements highlighted the inflationary risks while pointing to the uncertainty on world credit markets. Gibbs believes the prospect of much higher returns to dairy farmers, plus the likely impact of tax cuts, as being added inflationary risks in 2008.