Mortgage rates could hit 9 per cent before year end

3.45pm

Floating mortgage rates could be close to 9 per cent before the end of the year, despite the Reserve Bank picking that the pace of economic growth is now slowing down.

Reserve Bank Governor Alan Bollard today revealed his fifth interest rate rise this year, lifting the Official Cash Rate (OCR) from 6 per cent to 6.25 per cent.

The rise was widely expected especially after Finance Minister Michael Cullen all but confirmed the move in a parliamentary gaffe yesterday.

Dr Bollard warned a number of times in today's September Monetary Policy Statement (MPS) that more hikes were on the cards, on top of the 125 basis points tightening in the year to date.

The economy kept delivering "positive surprises" for the country, but this also meant that inflation was set to pass the bank's 3 per cent threshold and remain there until 2006.

Citigroup economic analyst Annette Beacher said another 25 points rise was close to 100 per cent certain in October and there was a risk of another 25 points lift in the OCR in December.

The bank's strongest signal of its future actions was its prediction that the 90-day bank bill rate would rise from 6.5 per cent to 6.75 per cent early next year and then remain stable.

The 90-day rate tends to follow the OCR and is a key driver of mortgage rates with most floating mortgage rates staying at a little over 2 per cent above the 90-day bank bill rate.

The MPS said that it was no longer true that a lift in interest rates immediately hit household spending due to the number of fixed term mortgages.

However, the year long rise in interest rates combined with a housing slowdown should be starting to bite into householders' pockets.

Economic growth had been stronger and longer than the bank expected and the likely slump would be milder and slower than usual.

Early last year the bank had been picking the economy to slump and cut the OCR from 5.75 per cent to 5 per cent.

Since then Dr Bollard has slowly squeezed up the OCR to one of the highest in the developed world.

Dr Bollard's Australian counterpart yesterday continued to freeze interest rates and there is now a 100 points difference between the two countries' cash rates.

Dr Bollard said the higher rates in New Zealand compared with the rest of the world were due to higher economic growth.

The bank predicted that the boom and bust cycle so typical of the New Zealand economy in recent decades would not take place this time, with annual economic growth to drop only to 2 per cent in 2006.

The Reserve Bank had a bet both ways on what risks the economy faced in the future.

It was more likely that the economy faced a downturn of a more serious nature than it did of the golden weather continuing.

World growth could slow more than feared if oil prices continued to rise, the dollar could fall lower than it was expected to do, commodity prices could dive and the cooling of housing prices could turn positively chilly.

On the other hand household spending and the local economy could continue to defy gravity.

"Domestically, the economy is heavily influenced by housing activity, which we expect to continue to slow over coming months. However, if that weakening is delayed, then household spending would continue to expand at a rapid rate, fuelling inflation pressures. This could be compounded by continuing strength in the labour market," the MPS said.

- NZPA