Get ready for two more rises

By BRIAN FALLOW

Another two interest rate hikes before the end of the year are a strong possibility after the Reserve Bank's hawkish monetary policy statement yesterday.

Governor Alan Bollard raised the official cash rate from 6 per cent to 6.25 per cent - as expected - and warned that further tightening was likely.

"The words promise one more in October, but the numbers are projecting two more," said Westpac chief economist Brendan O'Donovan.

The Reserve Bank has raised its interest rate projections, and now has 90-day rates holding at around 6.75 per cent through next year and 2006.

It predicts the exchange rate will stay high for another six months or so before it declines, and its short-term growth expectations are higher than they were three months ago.

"But despite markedly tighter monetary conditions, it still sees an inflation problem," O'Donovan said.

The bank believes inflation will stay at or above the top of its 1 per cent to 3 per cent target band next year and for the first half of 2006.

"The concern is that interest rates will exacerbate the downturn already coming from lower migration inflows, the prospect of house prices falling and the [delayed] effect of the exchange rate," he said.

Appearing before Parliament's finance and expenditure committee, Bollard said the bank's problem was that economic activity was peaking now, but inflation would not peak until next year.

"Obviously, we don't want to overcook and drive activity down unnecessarily next year."

But the risk that confidence in price stability would be shaken looked the greater danger at this point.

The Bank of New Zealand expects rates to rise another 50 points in the current cycle.

BNZ market economics chief Stephen Toplis said the economy had grown strongly over the past five years and had sustained that growth for longer than forecasters expected.

So a period of below-trend growth was needed to relieve capacity constraints and associated inflationary pressures.

He said factors that would slow the economy, such as the weakening housing market and the strong currency, were already factored into the Reserve Bank's forecasts.

The bank was predicting a recession in house-building and a fall in house prices. "It has to get those things to get its interest rate track as it stands. If it doesn't get them, other things being equal, it will need even higher rates," Toplis said.

National Bank chief economist John McDermott sees yesterday's increase and the promise of another in October as justified, but thinks that beyond that the Reserve Bank should wait and see how households respond.


Deutsche Bank chief economist Ulf Schoefisch wondered who the higher rates were aimed at.

"The housing market has already cooled off quite a bit. There is anecdotal evidence retail sales have softened. Does he [Bollard] want to see consumer spending decline?

"Maybe higher rates kill off a bit of investment, but do we want that when capacity is tight?"

Schoefisch said the byproduct of higher interest rates was a higher exchange rate.

Yesterday's move widens the gap between New Zealand and Australian interest rates to a percentage point.

The transtasman exchange rate, up from A86c in April to A93.25c before the announcement, jumped almost a cent after it to A94.17c.

The kiwi also gained almost a cent on the American dollar, going from US64.6c to US65.3c

Bollard said the bank took the impact on the exchange rate into account when setting the official cash rate.

"But it can't be the over-riding feature," he said.


He acknowledged the effect of a higher exchange rate on manufacturing exporters.

"But we have talked to a large number of exporters this quarter and we haven't had very much concern reflected back from them on that issue, partly because there is so much buoyancy in the domestic economy, which takes the pressure off," Bollard said.

"And, of course, exporters of resource-based products have been enjoying high international prices."