WELLINGTON (AFP) — New Zealand's central bank held interest rates steady on Thursday but indicated it would cut them before the end of the year amid forecasts that inflation will hit an 18-year high.
Reserve Bank of New Zealand governor Alan Bollard said the official cash rate (OCR) would remain at 8.25 percent, one of the highest in the developed world.
The New Zealand economy faced a "challenging environment of weak activity and high inflation," he said.
Inflation is expected to jump to an 18-year high of 4.7 percent later this year, well above the bank's mandated target range of one to three percent.
Higher food and oil prices are fuelling inflation, while economic activity is weakening due to the global credit crisis and a slowing housing market.
Following expected weak 0.9 percent economic growth in the current year to March -- down from around 3.0 percent in the March 2008 year -- the central bank sees only a slight pick up to 1.4 percent the following year.
"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," Bollard said.
He said he did not expected a protracted period of low growth and high inflation, known as stagflation.
"We're talking about a year of very low growth and a short-term inflation peak."
The bank is not forecasting a recession but Bollard said the possibility could not be discounted.
House prices are forecast by the central bank to fall from their peak last year by 13 percent in nominal terms and 23 percent, taking inflation into account.
The New Zealand dollar fell one cent to 77 US cents after the news, due to the prospect of lower interest rates later this year. It closed local trading Thursday at 76.57 US cents, down from 77.78 on Wednesday.
Westpac chief economist Brendan O'Donovan said the inflation outlook may be even worse than that forecast by the central bank.
"We see the risks around the inflation forecasts as skewed strongly to the upside," O'Donovan said.
The central bank was assuming that wage pressure would be contained but O'Donovan said he was not convinced that would be the case.
The central bank would be constrained in the extent it could cut interest rates if inflation pressures persisted, he said.
New Zealand share prices closed little changed in the face of the interest rate cut and a weaker Australian market, dealers said.
The NZX-50 gross index fell 1.72 points to 3,555.97 on turnover worth 117.8 million dollars (90.2 million US).
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