Bollard wary of early cash rate reduction

By COLIN JAMES

Shades of the mid-1990s, when inflation got away from the Reserve Bank, hung over Governor Alan Bollard's decision yesterday to hold the official cash rate.

He wants to cut but needs more evidence of slowing domestic activity.

Bollard warned that it would be harder to recover from a premature easing than a tardy one.

The decision was in line with almost unanimous market expectations of no change before the next six-weekly review on April 24 at the earliest.

But some in the markets felt Bollard had drawn back from his January position, and the dollar firmed slightly after the announcement.

Bancorp interpreted the decision as being about whether it was a good time to raise the cash rate.

"It seems that only recent currency strength held it back from making such a ridiculous decision."

Deutsche Bank chief economist Ulf Schoefisch said that because the markets had accounted for a small chance of an easing yesterday and a stronger chance of one next month, Bollard's statement "was interpreted as relatively hawkish".

But Stephen Toplis, chief wholesale economist at the Bank of New Zealand, stated bluntly that "the Reserve Bank wants to lower interest rates".

Toplis continues to put 50-50 odds on a cut in June and expects the bank to go for 0.5 per cent.

Westpac treasury economist Nick Tuffley said that "if anything [the bank] has moved slightly closer to a cut".

Bollard's problem is the roaring domestic economy, which continues to surprise with its strength.

One of the two criteria he set in January for an easing, a firm or strengthening dollar, has been met.

But he warned yesterday that currency movements were unpredictable (he projected a slight fall next year) and said the other criterion for an easing, "reduced pressures on resources and medium-term inflation", had not been met.

"Rapid population growth, rising unemployment and the earlier strength in the export sector have fuelled strong household consumption and supported higher resident investment and housing market activity," Bollard said.

"Capacity utilisation is high and demand for labour is strong. Inflation in industries serving the domestic economy is relatively high at around 4 per cent."

So "we do not have sufficient certainty about this medium-term inflation to warrant a cut in interest rates now".

Moreover, Bollard was coy about a later cut, saying there "may" be scope.

Yet the bank projects a "significant fall in export incomes" on the back of a weak global outlook and dry weather, lower net immigration, slowing domestic spending and residential investment and continued weak business investment, all contributing to an easing in domestic inflation to 3 per cent - and overall inflation from June onwards of 2 per cent, in the middle of the allowable 1-3 per cent range.

And that does not take account of uncertainties over an Iraq war.

What is holding the bank back? Fear of a repeat of the mid-1990s inflation surge in the wake of strong immigration and a housing boom.

Yesterday's monetary policy statement says "the policy mistake from which it would be harder to recover would be to allow a greater head of steam to build".

Former Governor Don Brash was mauled by commentators for the tardy response to the mid-1990s inflationary surge.