Reserve Bank Governor Alan Bollard has left the official cash rate unchanged at 8.25 per cent.
However he is indicating that the bank will be in a position to lower rates later this year as the economy slows quickly.
In making his expected decision to hold rates at the same level they have been since July last year, Dr Bollard said today that the RBNZ was projecting annual inflation to peak at 4.7 per cent in the December quarter. However, inflation was expected to return comfortably inside the targeted 1 per cent to 3 per cent range over the medium term.
"This is based on the expectation that commodity prices stop rising, inflation expectations remain anchored, and weakening economic activity contributes to an easing in non-tradable inflation," Dr Bollard said.
Economists have recently been predicting that the OCR will be lowered perhaps as soon as the September quarter after a series of economic indicators have shown the economy slower much more quickly than earlier predicted.
Dr Bollard conceded today that the outlook for economic activity was weaker than in the RBNZ previous monetary statement.
"We project little GDP growth over 2008 and only a modest recovery thereafter, largely reflecting a weaker household sector. Government spending and personal tax cuts will provide some offset to this lower growth but will also add to medium-term inflation pressure.
"Provided the economy evolves in line with our projection, we are now likely to be in a position to lower the OCR later this year, which is sooner than previously envisaged."
Since mid-2003 the RBNZ has increased rates 13 times from the then rate of 5 per cent. It has done this to try to counter inflationary pressures coming particularly from the strong rises in house values that occurred between 2002 and 2007.
However, in recent months, there have been a number of clear indications that the economy is slowing, with house prices easing, retail sales slowing and unemployment beginning to rise.
Some forecasters are now claiming that the country is in recession, while other commentators have been critical of the bank for not moving earlier to drop rates in order to provide some stimulation for the economy.
ANZ National Bank chief economist Cameron Bagrie said it was "very encouraging" to see the Reserve Bank look through the near-term blip in inflation and use the full flexibility of the policy targets agreement and the monetary policy framework.
"Bottom line is that we're not getting any growth so that means the medium term outlook for inflation is better and in that situation the Reserve Bank can take an appropriate monetary policy response, which it looks like they're prepared to do."
But Westpac economist Sharon Zollner said the Reserve Bank looked overly pessimistic on growth.
"They're picking a slowdown that's much longer than New Zealand typically sees," she said.
"In our experience it's not how the New Zealand economy works, and based on the fact some of the slowdown is drought-related we think there are factors that are going to cause growth to bounce back, so we would definitely see upside risks to their assumptions."
First NZ Capital chief economist Jason Wong said "it was a pretty good statement in a very challenging environment".
"It's softer than the market expected, but it's hard to disagree with what they're saying. We're seeing an oil shock, which while creating inflation pressure also creates a much weaker economic environment further down the track, which is what the (Reserve) Bank's reacting to."
Meanwhile, the New Zealand dollar plummeted on Dr Bollard's comments, from US78c just before the release to just above US77c within about 10 minutes.
- with NZPA
- Fairfax Media
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