Bollard keeps the brakes on a slowing economy

Alan Bollard

Reserve Bank Governor Alan Bollard says he expects to take his foot off the interest rate brakes, but not until next year.

Despite mounting evidence the economy is slowing, he left the bank's official cash rate unchanged at 7.25 per cent yesterday and said he did not expect to cut it this year.

In that case, floating mortgage rates seem unlikely to fall from their current level of around 9.5 per cent until next year.

But most economists continue to forecast that Dr Bollard will start cutting rates in the September quarter as it becomes clear inflation pressures are dropping faster than he expected.

Floating-rate loans make up about a third of all mortgages - 384,000 at the end of 2005 - but represent only 17.6 per cent of all mortgage debt.

More than twice as much, some $40 billion, is in fixed-rate loans at an average 7.3 per cent.

Dr Bollard is anxious not to reignite the housing market, by ensuring that as those loans roll off they are reset at higher interest rates.

The bank expects the average mortgage rate to be a bit over 8 per cent over the next year.

Dr Bollard said he needed to see the housing market continue to slow so that consumer spending moderated, reducing the upward pressure on prices.

The other key risk, he said, was "unrealistic" wage rises.

"Labour costs are pushing up this year despite the fact that many firms are quite squeezed in their capacity to pay."

Dr Bollard acknowledged firms were finding it difficult to pass wage rises on to their customers, but he remained concerned that they would contribute to a self-fulfilling expectation that inflation would stay high.

The bank forecasts inflation to fall back into its 1 to 3 per cent target band this year, and economic growth to slow to a low of 1.5 per cent over the next 12 months.

Meanwhile, Finance Minister Michael Cullen said one of the peculiarities of the "dip" in the economic cycle was the continued strength of the labour market.

"Labour shortages will keep wages and salaries up and house values, which are a major component of New Zealanders' wealth, are not expected to fall," he said.

But the Reserve Bank does expect house prices to fall by about 5 per cent from their peak, next year, though it notes that would still leave them at what were historically very high levels relative to incomes.