Westpac chief economist Dominick Stephens says that for some time, monetary policy has been in a bind.
Economic growth had picked up substantially on the back of Canterbury's postearthquake rebuild and house prices were now rising rapidly.
''In such circumstances, the Reserve Bank would normally lift interest rates in case inflation rears its ugly head in years to come.''
But for now, inflation was below the bottom of the central bank's 1% to 3% target band owing to low global inflation and the strong New Zealand dollar.
Hiking interest rates could push the exchange rate higher which would risk inflation dropping even further below target, he said.
The Reserve Bank was stuck and had been forced to keep the official cash rate on hold at 2.5% until at least mid-2014 before lifting it slowly.
The economy decisively outstripped the Reserve Bank's expectations over the six months to March, Mr Stephens said.
''We estimate growth over the half was 2.3% against the Reserve Bank's forecast of 1.4%. True, the summer drought will jostle activity levels through the middle of the year but this must be balanced against the temporary income boost New Zealand is receiving via record prices for dairy products on global markets.''
The Government had signalled a slight loosening of its tightly bound purse strings, he said. Importantly, the labour market was clearly improving and last year's spike to 7.3% unemployment was an aberration, he said.
Inflation and the exchange rate had changed little. Inflation was only slightly below target at 0.9%. The exchange rate was high, but no more so than the central bank allowed for in March. The drop in inflation expectations to 2.1% was a significant victory for the central bank that invented targeting, but again that was expected.
Mr Stephens expected the June MPS on Thursday to carry a slightly more ''hawkish'' tone than previously. The MPS would explain both sides of the high-growth versus low-inflation dilemma, but slightly more attention would be given to the improving economy than in earlier statements.
No change was expected in the last sentence of the statement which would report the central bank expected the OCR to remain unchanged through to the end of the year, he said.
''The most difficult aspect of the Reserve Bank's dilemma is that the longer interest rates stay low, the greater the probability of a boom/bust cycle in the housing market.
''This threatens the bank's financial stability goals, so it has been making noises about using macroprudential tools to ensure the stability of the financial system.''
Using such tools for financial stability reasons would affect the monetary policy outlook and would need to be taken into account at the release of the MPS, Mr Stephens said.
Reserve Bank governor Graeme Wheeler had previously talked up the possibility of restricting the proportion of new loans banks were allowed to make above a certain loan-to-value ratio (LVR).
''Mr Wheeler went on to make the case that these LVR speed limits might be a way of escaping - Houdini style - from the monetary policy bind.''
The proposition was that LVR limits might curtail house prices rises, effectively cooling the economy, Mr Stephens said.
The Reserve Bank raced the unenviable challenge of delivering a complicated messages to markets this week.
There was every possibility the market would overreact to one aspect or the other of the MPS, creating either a whippy price action or even a wholesale misfire the Reserve Bank would later have to correct in a speech, he said.
