Bollard keeps his finger off the trigger

By BRIAN FALLOW

Reserve Bank Governor Alan Bollard held off raising interest rates yesterday, but said it was a finely balanced decision.

"Depending on the data we will be prepared to move, and that would be in the nearer future," he said.

The projected track for interest rates in the December monetary policy statement released yesterday has the 90-day wholesale interest rate rising by three-quarters of a percentage point next year to 6 per cent. That would push floating mortgage rates to around 8 per cent.

Bank of New Zealand economist Stephen Toplis thinks the decision shows Bollard's true colours: "He's the sort of person that if it's a 50:50 call, he would prefer not to go."

A 75-basis-point tightening next year would reverse the easing Bollard delivered this year in the context of the Iraq war and a more sickly looking global economy.

The money markets had expected a rate hike, although with less conviction lately as the dollar continued to climb. Short-term wholesale interest rates fell when Bollard's statement was released.

Deutsche Bank chief economist Ulf Schoefisch said recent market pricing clearly underestimated the weight the Reserve Bank gave to the exchange rate trend.

"The rapid appreciation of the New Zealand dollar and its medium-term impact on the productive sector have become of increasing concern to the bank," Schoefisch said.

"With that back-drop the hurdle for [interest] rate increases will remain high and any tightening cycle next year will be limited."

The Reserve Bank emphasised that the interest rate rises pencilled in for next year were "small" or "modest" by historical standards.

It also stressed the medium-term focus of monetary policy decisions, that it was about how the tug-of-war between the now-hot domestic economy and the export-hobbling strength of the NZ dollar would play out over the next three years.

Migration is expected to provide a diminishing boost to economic activity over the next three years, as the net gain from migration slows from 40,000 to 20,000 a year. That easing is already under way.

It is expected to reduce demand for housing, while supply increases.

Bollard cited anecdotal evidence that at least the top end of the market might be cooling and reiterated his warning that some of the recent speculative activity in the housing market would prove costly for the investors involved.

Externally, the economic health of New Zealand's trading partners, Australia excepted, was rising, the bank said, while commodity prices had recovered [in world prices] and were likely to support future activity.

But the exchange rate, which has appreciated by nearly a third on a trade-weighted basis over the past two years, would have a "slow burn" effect, cutting exporters' income and subsequently their spending, a process that normally took one to two years to build to full strength.

The bank has built a higher exchange-rate track into its latest projections. It continues to assume that the dollar will gradually return to a long-run trend level, which it puts at about 58 on the trade-weighted index. But it is expected to stay about its present level of 65 for "several months" first.

Coupled with the higher interest rates projected, that represents a significant tightening of monetary conditions, but the bank still expects inflation to climb towards 2.75 per cent by the second half of next year.

It forecasts economic growth averaging 2.75 per cent over the next couple of years, lower than the 3.5 per cent averaged over the past five years but enough to take out the stresses built up during the recent burst of above-trend growth.