Bank chief hints at tightening

Reserve Bank Governor Graeme Wheeler said the LVR restrictions were designed to help slow house price inflation. Photo / Mark Mitchell

OCR stays at 2.5% for now, but Wheeler's eye on housing market and quake rebuild

Reserve Bank governor Graeme Wheeler served notice yesterday that how far he raises interest rates will depend on the housing market and how far pressures there spill over into general inflation.

As universally expected he kept the official cash rate on hold at 2.5 per cent and repeated that the bank expects to keep it there "through the end of the year".

But this time the comment is preceded by an acknowledgment that the removal of stimulus is likely to be needed.

"This firm tightening bias is new," said ANZ chief economist Cameron Bagrie.

Previous statements from the bank have been more symmetrical, balancing the risks of an overvalued dollar against those of an overheating property market in Auckland.

But since the June review the dollar has dropped below US80c and the level of concern has been downgraded, though only slightly, with the exchange rate now described as "high" rather than "overvalued", said Westpac chief economist Dominick Stephens.

He finds it significant that for the first time in a long while the bank has linked the expected rise in inflation to rising house prices and the construction boom.

He sees it as the bank abandoning what he considered sanguine assumptions that in this cycle rising house prices would not fuel much extra consumer spending and that the Canterbury rebuild would be less inflationary than previous building booms.

Wheeler said growth was picking up and, although uneven, becoming more widespread.

"Consumption is increasing and reconstruction in Canterbury will be reinforced by a broader national recovery in construction activity, particularly in Auckland.

"This will support aggregate activity and eventually help to ease the housing shortage," he said, before again warning that the bank does not want to see financial or price stability compromised by housing demand getting too far ahead of supply.

Bagrie said the Reserve Bank would eventually be forced to use its primary policy instrument, the OCR, but for now the combination of conflicting forces on the outlook and low current inflation - 0.7 per cent in the year to June - was buying it time.

A housing boom would sorely test the hypothesis that there has been a structural change in households' behaviour, towards more saving, he said.

"The fact is New Zealand can ill afford a construction and consumption boom at the same time. The latter needs to give way to the former. Gauges like consumer confidence, credit growth, and durables spending will be key."

ASB chief economist Nick Tuffley said the Reserve Bank's focus on the spillover effects of the stronger housing market and construction activity on inflation pressures meant purely domestic inflation pressures would become more prominent in its thinking.

"We continue to expect [it] to keep the OCR on hold until March 2014 before gradually rising to 4 per cent in late 2014."