Bollard hikes cash rate to 7.25 per cent

Reserve Bank governor Alan Bollard

Reserve Bank (RB) governor Alan Bollard has again raised the official cash rate (OCR), in his latest attempt to subdue the rampant property sector and curb rising inflation.

As widely expected, Dr Bollard today raised the OCR by 25 basis points to 7.25 per cent.

And rather than Christmas cheer, Dr Bollard opted to dish out words of warning that today's hike may not be the last.

"Whether further tightening is needed will depend on the extent to which housing demand pressures show signs of moderating over the months ahead.

"However, we do not yet see any prospect of a policy easing in the foreseeable future," he said in his quarterly Monetary Policy Statement (MPS).

While exporters have been under pressure from the high New Zealand dollar and business sentiment has fallen, the expected slowdown in the domestic economy had failed to fully materialise as rising house prices and rapid growth in household borrowing continued to fuel spending.

Data released over the last quarter showed unemployment at a 20-year low of 3.4 per cent, accelerating wage growth, and house prices still on the rise -- sitting about 15 per cent higher than the RB had envisaged this time last year.

The fact that the majority of home loans in New Zealand were on fixed interest rate terms, rather than floating interest rates, meant there were time lags between when many home owners felt the effects of the official rate rises.

Dr Bollard said these lags meant the previous OCR hikes had yet to be fully felt by the market, and the challenge in setting the OCR was figuring out to what extent the effect of previous hikes were still in the pipeline.

"If we misread the lags, there is a risk that policy tightening undertaken now will start to bite just at the point when domestic demand is already cooling," he said in the MPS.

But he added that not raising the OCR, for fear of turning a soft landing hard, could allow inflation pressures to escalate to uncomfortable levels.

Inflation has already breached the RB's target range of 1 to 3 per cent, with annual inflation hitting 3.4 per cent in the September quarter.

The RB said today it expected inflation to remain around 3.5 per cent until June next year. This was slightly lower than projections of around 4 per cent made in the previous MPS, as oil prices had fallen more quickly than expected.

The potential effect of today's rate rise on the already strong New Zealand dollar has exporters and farmers worried.

At 7.25 per cent the OCR is the highest official interest rate in the industrialised world, making the kiwi dollar popular with yield-hungry investors.

The OCR compares to 5.5 per cent in Australia, 4 per cent in the United States and 2.25 per cent in the euro zone.

The New Zealand dollar dipped to US70.09c on the rate news, against its US70.27c local open. That was partly a case of "buy the rumour, sell the fact", although the downward momentum began yesterday following a slew of dour economic forecasts.

Federated Farmers president Charlie Pedersen this week urged Dr Bollard to hold fire on any more rate rises. He said farmers were already under a lot of pressure as the high kiwi had wreaked havoc for exporters.

His comments came as the New Zealand dollar hit A95.83c, its highest level since the kiwi was floated 20 years ago.

The trade weighted index -- which measures the kiwi against a basket of major currencies -- also hit a post-float high this week of 74.51, while the kiwi also rose against the US dollar.

The New Zealand dollar flirted with US72c, before easing on concerns about a Standard & Poor's rating review. S&P kept its high rating on the New Zealand dollar, but said maintaining that level depended on the current account deficit returning to historical levels. New Zealand's current account deficit blew out to 8 per cent of GDP (gross domestic product) in the year to June. The RB said today it expected the deficit to peak at 9.25 per cent by late next year.

Economists said there were no real surprises in today's MPS.

"They're aware of the pressure on the currency, the upward pressure," ASB Bank chief economist Anthony Byett said.

"They're also aware of the strong domestic spending, so they're trying to look for that balance where they keep that clear message that we need to rein in that domestic spending, and at the same time they don't want to exaggerate that currency issue."

Mr Byett expected the bank to raise rates again in January, although he admitted it was a "close call".

Robin Clements, a senior economist at UBS, said the bank had painted itself into a corner with its narrow focus on household spending and housing.

"To have not hiked would have damaged their credibility."

- NZPA