KEY POINTS:
Reserve Bank Governor Alan Bollard effectively yanked the monetary reins tighter yesterday, even though he left the official cash rate on hold at 7.25 per cent.
The statement announcing the rate decision was seen as extremely hawkish, so wholesale interest rates rose and the kiwi dollar recovered after slipping more than half a cent against the greenback.
Sean Keane of Credit Suisse in Singapore said swaps market pricing now implied a 100 per cent chance of a rate hike in either March or April, with March seen as the more likely.
He thinks that, if Bollard does hike, he will do it more than once, although market pricing does not yet reflect that.
The interest rate swaps market reflects the cost of offshore funds banks use to finance fixed-rate mortgages. Even before yesterday's decision it was difficult to find a fixed-rate home loan at less than 8 per cent unless borrowers were prepared to fix for five years, and even then the rates were not much below 8 per cent.
But the housing market has, if anything, been gathering strength, with one gauge of house price inflation hitting 11.9 per cent last year.
The market features prominently in Bollard's menacing statement.
"Our assumption that the housing market and consumer demand will resume their slowing trend over 2007 and 2008 is looking more uncertain, particularly if further fiscal expansion occurs," Bollard said.
"In the absence of clear indications of a moderation in housing and domestic demand it is likely that further policy tightening will be required," he said.
The previous statement in December had only said firmer monetary policy "could" be required.
"If the [Reserve] Bank is so convinced a future rate hike is likely, why didn't it move today?" asked Bank of New Zealand head of research Stephen Toplis
He questioned how much longer Bollard could keep on crying wolf - threatening to act if domestic demand did not cool, but not following through.
"There comes a point time when buying yourself time is entirely inappropriate, because you risk allowing the economy to push ahead to a level where you won't need one rate increase to bring it under control but three or four or five," Toplis said.
"By pussyfooting around they are encouraging the currency to forge higher because currency partners are saying: 'Look the economy is not going to soften at those interest rates'."
Deutsche Bank chief economist Darren Gibbs agreed.
"By delaying a rate hike by a further six weeks - one that we think is already overdue - Dr Bollard has simply put a floor under the exchange rate. A sustainable decline in the exchange rate seems unlikely whilst an eventual easing monetary policy is nowhere on the horizon," Gibbs said.
Where previous statements had warned that an easing was a "considerable way off", the latest one does not mention easing at all.
ANZ National Bank chief economist Cameron Bagrie believes interest rates will remain on hold until 2009 - an exceptionally long time to spend at the top of the cycle when the OCR has already been at 7.25 per cent for more than a year.
"We are not buying into the story that the economy is on a sustained recovery as recent indicators suggest, so we don't see the need for rates to move up, but we find it difficult to present a case for rates to move lower, even a year out."
Westpac chief economist Brendan O'Donovan has joined what is now the majority view among market economists - that Bollard will hike in March.
The factors driving the recent pick-up in economy growth - immigration, higher commodity prices and lower oil prices, and fiscal expansion - were not flash-in-the-pan things.
"They have legs, so in all likelihood we we won't see the moderation in housing and domestic demand he says is essential," he said.
"But we don't know how broad his lexicon is. What comes after likely? Almost certainly?"
