RBNZ's Bollard says inflationary expectations the key

Reserve Bank Governor Alan Bollard has said in a Radio New Zealand interview that he can continue to look through the current spike in inflationary pressures and be flexible with monetary policy as long as inflationary expectations remain under control. Asked if there was a greater public tolerance for inflation being above the bank's 1-3% target band for an extended period, he said: "Yes, subject to other people finding us credible." Bollard said this could be measured in various ways. "One is that we survey inflation expectations. If people don't expect inflation to get out of hand...ie they think we can do our job...they won't factor that in to very big wage increases, very big price increase and very big margin increases, and we will find we don't have that inflation," he said. "If we lose credibility, that's another story altogether and we might need to get hard line again." Asked if inflation expectations were out of hand, he said: "No. Our surveys say that that's not the case. They do say short term people see spiking inflation." Bollard referred to a drift up in inflationary expectations in a speech last week, but that this was consistent with the recent lift in headline inflation and remained in line with the target range of 1-3%. The Reserve Bank's own survey of business leaders' inflation expectations in two years time showed an average expectation of CPI inflation of 2.9%. Asked how long the Reserve Bank could stretch out its period of flexibility, Bollard said: "We're at the edge of our stretch at the moment. We've got nasty inflation right at the moment. We think it's going to get worse next quarter, but then think it's going to come off, but that's a forecast." "We're out there saying what it's going to be like a year or so ahead. We think it'll be back inside (the target ). Comfortably? Well only just." "So does that give us enough room to cut? Given the softness around the economy..yes?. In a softening economy people are going to be very hesitant about price increases, so that's given us enough room to cut. We've got more room now." Asked if price setters were trying to pass on higher prices, Bollard said: "There's a bit of sign but generally business people are saying we'd love to increase prices to restore our margins, but the market is soggy and that limits them." Bollard said he had an easier time of it than previous Reserve Bank governors, such as Don Brash, who had to hammer inflationary expectations lower with less flexible inflation targeting. Bollard said the current Policy Targets Agreement between himself and Finance Minister Michael Cullen requires the Reserve Bank to "minimise unnecessary instability in output and exchange rates and interest rates." "That says don't get too cute about these things. We've got to be aware of the broader objectives of government and we've got to allow for flexibility," he said.