Reserve's quest for happiness

The penultimate words for this month come from the Reserve, taken from its February quarterly statement of monetary policy (with paragraph breaks inserted to aid the elderly): "The central forecast is for year-ended underlying inflation - currently around 3 per cent - to fall to 2 per cent in 2007 and 2008. With the recent falls in oil prices and the unwinding of the banana price increases, headline CPI inflation is expected to fall below 2 per cent in mid 2007 before rising to be about the same as underlying inflation later in the forecast period.

"These forecasts represent a modest downward revision to the inflation forecasts contained in the previous statement, reflecting both the evidence that underlying inflationary pressures in the second half of 2006 were somewhat weaker than in the first half, and the likelihood that recent falls in world oil prices (Ooops!) will result in some dampening effect on cost pressures and inflation expectations.

"But many of the factors that have pushed up underlying inflation over the past few years persist. Ongoing labour market tightness is likely to keep wage growth at above-average levels.

"In addition, upstream price pressures appear to remain reasonably strong, and capacity utilisation in the economy has been high and is only expected to ease modestly. Hence the reduction in inflation is likely to be only modest, and outcomes are forecast to be in the upper half of the target band over the next few years.

"Overall, risks to the forecasts appear to be broadly balanced."

Henry confesses to feeling less relaxed and comfortable than this. There are three real upside risks for inflation: wage push inflation, oil price inflation and nuclear war inflation. This is why we called for pre-emptive action late last year and continue to see the need for at least one more rate hike this year.