The Reserve Bank left the official cash rate (OCR) unchanged at a record low 2.5 percent, but economists noted it is no longer "comfortable'' with the inflation outlook.
In comments accompanying a muted Monetary Policy Statement (MPS), published today, Reserve Bank Governor Alan Bollard indicated he continued to expect to start lifting the official cash rate (OCR) around the middle of 2010.
He also mentioned that higher bank funding costs would help reduce the size of OCR increases needed in future.
From an annual rate of 2 percent in the December quarter, inflation is expected to reach 2.7 percent in 2012, excluding the impact of the emissions trading scheme (ETS), the Reserve Bank said. ACC increases this year were also expected to be larger than usual.
Provided price and wage setters recognised the rise in prices as one-off in nature, and formed their expectations and behaviours accordingly, the implementation of the ETS should not affect medium term inflation, the MPS said.
ANZ chief economist Cameron Bagrie and senior markets economist Khoon Goh said today's MPS was noteworthy for providing more emphasis on the inflation outlook.
On the face of it, the short term outlook in the MPS for inflation to move close to the top of the Reserve Bank's 1 to 3 percent band, even when the ETS effects were removed, did not give much headroom.
The medium term inflation outlook was still expected to remain within the target range, although the Reserve Bank had removed the work "comfortable'' which it used in its January review, the ANZ economists said.
The Reserve Bank was well aware forthcoming inflation numbers would have greater noise than usual, not to mention any changes to GST, which were omitted since it was not yet official government policy.
ASB economists also noted that the Reserve Bank no longer felt "comfortable" about the inflation outlook.
First round effects of the ETS were expected to add about 0.4 percent to headline consumer price index inflation in the year to June 2011, and if the impact of a GST increase were added, they expected the Reserve Bank would become "increasingly uncomfortable with the upside risks to underlying inflation".
"The RBNZ is assuming that inflation expectations will remain anchored, but this series of one-off events poses a risk to this assumption," the ASB economists said.
Increased pricing intentions in the construction sector in recent months pointed to a rebound in construction costs, which the ASB economists expected to be a key driver in a rebound in non-tradable inflation, which covers goods and services with no foreign competition.
In contrast the Reserve Bank was forecasting a relatively muted rebound in non-tradable inflation from the December quarter's surprisingly weak 0.1 percent increase, they said.
Furthermore, the Reserve Bank was expecting the depreciation in the NZ dollar during the second half of 2009 to lead to a further decline in tradeable inflation -- covering goods and services that are imported or in competiton with foreign goods.
"While we expect weak household demand to place downward pressure on the retail prices for recreational items, this will be offset by increases in petrol prices," the ASB economists said.
"Just this week petrol prices rose to the highest level in 18 month. With the RBNZ already projecting inflation to rise to close to the top of the target band, any upside surprises will be concerning."
At a briefing after the MPS release, Dr Bollard said the Reserve Bank would look through the first round effects of a GST rise.
"We would move the official cash rate only if we saw people trying to take advantage of an increase in GST to otherwise increase wages or margins. So we'd stand against any second round increase like that."