Bollard focus of high-stakes poker game

Alan Bollard. Photo / Mark Mitchell

Alan Bollard is in a staring match with financial markets who bet that signs of economic recovery will see the Reserve Bank governor blink first this week and abandon his stance that the official interest rate will remain low for a further 12 months.

Ahead of Thursday's Monetary Policy Statement, economists at the major local banks, who - by and large - expect no change from the OCR's current 2.5 per cent, are backing Bollard to hold steady in his view.

Markets, however, are pricing in expectations that he will tighten much sooner, in about March.

Major bank economists. with the exception of those at ASB Bank, are picking no change in terms of the OCR and the outlook for increases but some are looking for change in Bollard's rhetoric.

"We think given clear signs of improvement both domestically and internationally, the Reserve Bank will shift to a neutral stance" said ANZ senior market economist Khoon Goh.

"They will remove the easing bias that is inherent in their last statement but will remain committed to keeping rates low for some time.

"In some respects part of the market pricing is a reflection of the fact that things are starting to improve and part of what's been driving the rates market here is a reassessment of the Reserve Bank of Australia, which has indicated its next move will be up.

"They haven't committed to when that will be but the markets there are now pricing in rate hikes before Christmas," said Goh.

"Part of that has flowed into our market, but our view is there is still enough uncertainty about the recovery path that the RBNZ will not be rushing to tighten any time soon, and I think the interview the governor gave early this week was quite telling in the way he remarked about current pricing."

Bollard last week said: "The financial markets either want things to go down or they want things to go up. They just don't seem to do stability very well."

Like ANZ, Westpac economists also noted the influence of positive domestic and international indicators, particularly the rally in milk powder prices.

"With the improvement in the New Zealand data, the improvement in confidence, the much improved international commodity prices, the increase in the housing market, and the migration turnaround, the data justifies that easing bias being removed," said Westpac chief economist Brendan O'Donovan.

"But I'm not convinced the RBNZ will take it out.

"They're not convinced over the sustainability of either the domestic or international recoveries, and they're very concerned about the level of the exchange rate.

"It plays a major role in their inflation forecasts - perhaps more than the market appreciates."

With its usually favourable yield and its ongoing volatility, the New Zealand dollar is one of the favoured currencies on global forex markets with total annual turnover in the kiwi exceeding our gross domestic product by a factor of 18, the Opposition's banking inquiry was told last week.

Market participants have been tipping the kiwi to extend its recent strength on prospects Bollard will hike sooner than previously indicated.

"New Zealand may surprise people as one of the first central banks to tighten," said David Tien, a US money manager.

"The market's always got its own views, and often it's wrong," Bollard told Radio New Zealand.

While he acknowledged the economy had turned for the better, BNZ senior economist Craig Ebert noted, "There is little, as yet, to guarantee it will naturally transform into the strong and sustained upswing required for us all to climb out of the big hole we're in.

"Folk run the risk of getting overexcited," he said, noting the Governor's recent comments seemed designed to lean against that.

A high exchange rate, said Ebert, leaned hard against the notion of a strong or sustained domestic recovery.

With currency intervention unlikely to be a realistic option, Ebert said the Reserve Bank might yet be forced to trim the OCR again to take steam out of the kiwi dollar although that was not BNZ's core view.

ASB economists, however, are tipping a 25-point cut.

They note that under the influence of improving global prospects, the Reserve Bank of Australia's increasingly hawkish view and rising long-term local mortgage rates, monetary conditions have continued to tighten, which the RBNZ said in July might lead to a reassessment of its policy stance.

While staying on hold this week might be the easy choice, a cut would be the more courageous one, ASB said.

"Trying to talk the NZ dollar and interest rates down has had no lasting effect, and inaction risks further undermining the RBNZ's attempts to try condition rate hike expectations.

"The market is calling the RBNZ's bluff: if it folds the market will continue to up the ante on rate hikes."