There have been sharp falls in consumer and business sentiment, exacerbated by tighter credit conditions, a further decline in the housing market and weaker prospects for world growth.
Financial market turbulence around the world continues to add to an uncertain economic environment. Further, the very dry summer is also weakening short-term growth prospects.
However, the labour market is still strong and New Zealand's key international commodity prices remain high. Government spending plans and the possibility of personal tax cuts can also be expected to limit the economic slowdown.
The weaker economy will, over time, ease accumulated pressure on resources and reduce inflation pressure. However, short term inflation is likely to remain persistently high, due in large part to repeated increases in food and energy prices.
There is a risk that wage settlements respond to these short term price shocks rather than adjusting to the changing economic conditions, thus perpetuating inflation pressures.
We see significant downside risk to future activity but upside risks to inflation. A further risk to the outlook is the persistently strong New Zealand dollar which, while helping moderate headline CPI inflation, remains a drag on export growth.
Given this outlook, we expect that the OCR will need to remain at current levels for a time yet to ensure inflation outcomes of 1 to 3% on average over the medium term.
