Bollard admits interest rate hike risks hard landing

Reserve Bank Governor Alan Bollard tightened the interest rate screws again yesterday even as he acknowledged the risk that the economy could suffer a hard landing next year.

As expected, he raised the official cash rate from 7 to 7.25 per cent, the ninth increase since the start of last year.

Most economists and the money markets believe it is likely to be the last rise in the series, but Dr Bollard warned that whether any more tightening was needed would depend on how much the housing market and household spending slowed in the months ahead.

The Reserve Bank forecasts economic growth, currently around 3 per cent, to slow to 2 per cent over the year ahead and 1.5 per cent the year after.

But it admits there is a risk the slowdown may be faster than that - the "hard landing" scenario.

Bank of New Zealand chief economist Tony Alexander said a hard landing was bad but not a recession.

"It means growth going maybe to below 1 per cent, and a lot of worry and despondency.

"A New Zealand hard landing is everybody talking about going to Australia."

The Reserve Bank expects house price inflation, currently running around 15 per cent, to flatten off in 2006 to the extent that house prices even drop 5 per cent or so, compared with a year earlier, by the end of the year.

It expects that to trigger a sharp slowdown in consumer spending.

That is necessary, the bank believes, if inflation, currently 3.4 per cent, is to be brought back under control.

Households' willingness to spend has outstripped growth in the goods and services the economy produces. That extra demand pushes up prices and sucks in imports well in excess of what we can pay for from exports.

Collectively households are spending about 14 per cent more than what they are earning, even with more jobs and higher wages.

Spending has been turbocharged by the so-called "wealth effect" - where homeowners calculate the increase in the value of their properties and happily borrow against that to spend on other things.

But with household debt at high levels and mortgage rates rising, the bank expects that effect to run out of steam next year.

Around 80 per cent of mortgage debt is at fixed rates, mostly for one- and two-year terms, and those rates have been climbing.

New borrowers and those whose fixed-rate loans have to be refinanced now face rates close to half a percentage point higher than three months ago.

About 40 per cent of all fixed-rate loans will be reset over the year ahead. The average rate these borrowers are paying now is 7.2 per cent.

The bank estimates they will face increases of at least 0.6 or 0.7 percentage points.

In some cases the increase will be more than a full percentage point.