Bollard damps down talk of early rate rise

The wording of Alan Bollard's statement about the official cash rate yesterday drew close attention. Photo / Mark Mitchell

Reserve Bank governor Alan Bollard has moved to rein in market expectations that the official cash rate could start to rise as soon as the new year.

As they almost always do, the markets had correctly anticipated the actual rate decision - no change from the all-time low of 2.5 per cent. The focus was on the semantics of the accompanying statement.

The bank's line since April 30 had been "we expect to keep the OCR at or below the current level through until the latter part of 2010".

It has now dropped the "or below" - to no one's surprise - and changed "latter part" to "second half", leaving the market to work out whether that signals an earlier start to the tightening or not (in which case why change it?).

The immediate market reaction was to lower short-term interest rates and the NZ dollar.

The bank's statement gives a nod of acknowledgment to the run of data since the last OCR review six weeks ago which have encouraged the markets to drive up short-term wholesale rates.

New Zealand's trading partners are rebounding though "significant vulnerabilities remain".

Domestically the housing market has largely recovered, household spending is increasing - "very gradually" - and Government spending is supporting economic activity.

But the bank also points to weak business spending, subdued credit growth and, most of all, the high dollar.

"The current composition of growth continues to raise questions about its sustainability."

Westpac chief economist Brendan O'Donovan said that in light of the upward pressure on banks' funding costs an OCR of 2.5 per cent right now was more like a 4 per cent rate in terms of its impact on borrowing rates.

But that was still very low and at some point the Reserve Bank would have to start taking the stimulus back, he said.

"They do have time on their side. We are only in the early stages of recovery. There is plenty of spare capacity in the economy and not much inflation risk in the near term," he said. "But I'm not sure they have as much time as the second half of next year. That is a long while away."

O'Donovan would have preferred the Australian approach of early, gradual rate hikes with pauses to observe the effects. Bollard had revealed his preference for the other strategy, "to go late and that will probably require them to go hard".

"We have had 4 per cent house-price growth and this is flashing the green light to the household sector," O'Donovan said. "They say they are concerned about the sustainability of growth, particularly about housing and a credit-fuelled pick-up in consumption. They are concerned, but don't want to do anything about it."

But ANZ National Bank economist Khoon Goh shares the central bank's caution over the economic outlook, and sees a need for keeping rates on hold for some time.

"The high currency and rising longer-term fixed mortgage rates have been doing some tightening work for the Reserve Bank over recent months. In addition, fiscal policy will start becoming more contractionary over the year ahead. This leaves the bank having to provide support for longer," he said.

But he agrees with O'Donovan that a "lower-for-longer stance will invariably bring more aggressive moves when the process of policy normalisation is required".

ASB economist Jane Turner said the statement was "a little contradictory, in saying rates will remain low until the second half of next year yet expressing concern that credit growth might trigger stronger domestic spending".

"In other words, the Reserve Bank is saying it intends to keep interest rates low but doesn't want anyone to borrow more money."

That tension and the likelihood of continued demand for housing would increasingly challenge the central bank, Turner said.

"We expect that the ongoing recovery in the domestic economy will trigger an earlier start to OCR increases than today's statement suggests.

"We expect a 50-basis point hike in April."