Bollard tightens screws by boosting interest rate

Alan Bollard

Reserve Bank chief Alan Bollard yesterday followed through on his threat to raise interest rates in a bid to cool a "relentless" housing market.

He raised the official cash rate from 6.75 to 7 per cent and warned that further tightening of the screws could be ruled out only when he saw "a noticeable moderation in housing and consumer spending".

The money markets now rate as better than 50:50 the odds of a further rise on December 8.

Banks last night were holding floating mortgage rates steady but any move will push them beyond 9 per cent.

The official cash rate is the highest among developed countries, which helps to keep the NZ dollar high, hurting the export sector as well as pushing up the cost of business overdrafts.

"It has increased the risk of a recession, though we are not forecasting one," said BNZ economist Stephen Toplis.

Echoing the theme of a speech two weeks ago, Dr Bollard said: "The most serious risk to medium-term inflation is the continuing strength of household spending, supported by a relentless housing market and rapid growth in mortgage lending."

But his problem is that only 20 per cent of mortgage debt these days is at floating rates and those loans are on average $53,000, half the size of fixed-rate loans.

Any move by the banks in response to the announcement yesterday would increase the cost of floating-rate loans by $2.55 a week on average, which is not on its own expected to halt the housing boom.

In former governor Don Brash's time, when most home loans were at floating rates, he could in effect reach into borrowers' pockets to take spending power out of the economy.

Now, with the prevalence of fixed-rate loans, it is as if mortgagors have sewn zippers into their pockets. But fixed-rate loans, most of which are for one- or two-year terms, are also becoming more expensive as international interest rates rise.

Loans taken out at rates below 7 per cent in 2003 are being reset at around 8 per cent when they come up for renewal. Dr Bollard expects that, together with yesterday's move, will slow the housing market and household spending.

Economists see the rate hike, against the backdrop of a weakening economy and gloomy business sentiment, as evidence that Dr Bollard got it wrong last year, giving the economy too much benefit of the doubt and raising rates in a hesitant way.