Inflation in New Zealand has spiked this year and a rebuilding frenzy after the February earthquake could keep it uncomfortably high.
That augers for the Reserve Bank of New Zealand (RBNZ) to raise rates at a meeting on Thursday.
But it almost certainly isn't going to happen, as New Zealand - like more and more countries - wants to hold rates as the global economic picture darkens, damaging chances for growth.
Global gloom is the second big external or unexpected factor that RBNZ governor Alan Bollard has had to deal with this year. The first was the earthquake, which devastated Christchurch, the second largest city.
The RBNZ responded in March with an emergency 50 basis point cut in the Official Cash Rate (OCR), to a record-low 2.5 percent, to cushion the economy from the earthquake's negative impact.
In July, New Zealand reported annual inflation of 5.3 percent for the second quarter, a 21-year high. That month, the RBNZ held the OCR, saying much of the price spike was due to a sales tax increase.
The central bank also said there was little need for the OCR to stay at 2.5 percent should global financial risks recede and the economy continue to recover. Those comments, plus the RBNZ's inflation target band of 1-3 percent, created expectations of a rate hike at the next meeting, on September 15.
But now, global financial risks have definitely increased - which, to many, means the RBNZ won't be able to raise rates any time soon.
With the worsened picture, there are worries about longer-term growth - and whether there will be any. New Zealand achieved quarter-on-quarter growth of 0.8 percent in the first three months of 2011 and for the April-June period, to be announced on Sept. 22, economists have forecast 0.6 percent.
Shamubeel Eaqub, the principal economist at the private New Zealand Institute of Economic Research, thinks the OCR might remain at 2.5 percent until June next year.
His view is that a major change in New Zealand's house-mortgage structure in recent years gives the RBNZ both a reason not to raise rates now, and a way if needed later to quickly bring down inflation.
Floating rate mortgages have risen to nearly 57 percent of the total outstanding loans of around NZ$170 billion, from 12.4 percent in 2007, when the OCR was 8.25 percent.
Eaqub says that given the massive shift to floating-rate mortgages, an increased OCR rate would directly knock consumption.
New Zealand has high levels of household debt, the stock of which stands close to 160 percent of disposable income after peaking at 170 percent in 2007. The low, in 1990, was 60 percent. With the level high, any rate increase will bite.
Eaqub said a 1 percentage point increase in rates would raise the total annual mortgage bill in the economy by some NZ$1.4 billion, or 2.2 percent of annual retail spending.
The impact of a rate increase on the household sector "would be very rapid," he says.
In Eaqub's view, the sharp impact on consumption is why the RBNZ, keen on maintaining growth, is unlikely to increase the OCR soon. But later, if there's a need to decisively attack unacceptably high inflation, a rate rise could do it, giving the RBNZ the flexibility "to react to events as they arise," he says.
The RBNZ's two-year inflation expectations - a key gauge because it's seen as the timeframe for policy action to filter through to prices - eased to 2.86 percent in the third quarter from 3.0 percent in the second quarter. Still, that's on the high side of the target band, keeping the bank vigilant.
New Zealand, unlike Singapore, does not use foreign-exchange policy as a tool for combatting inflation. With interest rates low, the RBNZ hasn't had to worry about the kind of inflows of hot money that the country had in 2007-2008. Foreign holdings of New Zealand Government Securities have been steady at close to 60 percent.
The New Zealand dollar hit a 30-year peak against a wobbly US dollar this year, but the kiwi has weakened recently as money has flowed instead into safe havens such as US Treasuries. In July, the RBNZ said a high kiwi dollar would reduce the need for rate increases in the short-term.
The latest Reuters poll of 18 analysts showed a majority expects an increase in December or later, with only four economist expecting a hike on Thursday.
That compared with a clear preference for September in earlier polls.
Financial markets now also imply only a 9 percent chance of a 25 basis point of increase in the OCR this week, down from bets of a 50 basis point hike in August.
It's difficult for RBNZ to argue for rate increases now while many others are pausing or even cutting their key rates. The Reserve Bank of Australia held its key rate unchanged at 4.75 percent for a 10th month last week, saying best for policy to stay steady in times of great global uncertainty.
"The New Zealand economy is doing pretty well. But it's just going to be completely swamped by what's happening offshore," said AMP fixed income head Grant Hassel.
"In that kind of environment, you want to be patient and wait and see what is going to unfold."
