Governor tipped to raise rate sooner

The Reserve Bank is expected to signal on Thursday an earlier start to interest-rate tightening than the "latter part of 2010" which has been its mantra since May.

Market economists are unanimous that governor Alan Bollard will leave the official cash rate at its all-time low of 2.5 per cent this time.

But the run of economic data since the last OCR review last month has seen a wide credibility gap open up between market expectations of what the bank will do and its official position, reiterated on September 10, that "we continue to expect to keep the OCR at or below the current level through until the latter part of 2010".

Pricing in the swaps market implies the OCR will be 4.5 per cent in a year and a better than even chance that Bollard will start tightening as soon as January.

Economists' forecasts, typically, are less aggressive but a Reuters poll of 18 forecasters found five expect the governor to have raised the OCR by the end of March and another eight expect it raised by the end of June.

Since the September review the outlook for the world economy has improved, the housing market has been going strong, business and consumer confidence have climbed, June quarter gross domestic product came in stronger than expected, and so did inflation in the September quarter.

An important offset to that run of rosier news has been the strength of the New Zealand dollar.

It has delivered its own tightening of monetary conditions, albeit in the "wrong" parts of the economy.

Since the last OCR review six weeks ago the kiwi dollar has gained 6c or nearly 9 per cent against the US dollar and appreciated 6 per cent on a trade-weighted basis. That means it is nearly 9 per cent higher than the Reserve Bank assumed it would be over the course of 2010, thereby reducing inflation pressures and leaving less work for interest rates to do.

Among the factors to be weighed against that is a pick-up in the global economy. Consensus forecasts have it shrinking significantly less this year and growing significantly more next year than had been expected at the time of the bank's September forecasts.

The impact on commodity prices has been enough for dairy company Fonterra to lift its forecast payout.

On the domestic front the housing market continues to heat up.

"Over the three months to September house prices have increased at an annualised pace of 10 per cent," said ASB chief economist Nick Tuffley.

He does not expect this to last, as the rise in prices attracts more sellers and encourages new construction.

But in the meantime the surge in house prices would certainly test the Reserve Bank's patience, Tuffley said.

Westpac chief economist Brendan O'Donovan said the sight of house prices back to just 4.4 per cent below their 2007 peak would be fuelling the Reserve Bank's concerns about unbalanced growth.

"And the only way for monetary policy to reverse that trend is to lift mortgage rates."

Meanwhile, June quarter GDP not only marked a return to growth earlier than most forecasters had expected, but recorded a big unwind in the level of inventories.

"It was massive, equivalent to 2.5 per cent of GDP," O'Donovan said, "and even if inventory levels stabilise from here it means a greater share of future demand will be met through new production."

After five quarters of contraction the amount of slack in the economy ought to keep inflation pressures subdued for some time.

So the September quarter consumers price index, up 1.7 per cent annually when the Reserve Bank and other forecasters were expecting 1.2 or 1.3 per cent, came as a shock.

Measures of underlying inflation were stubbornly high, including non-tradeables inflation at 3 per cent and the CPI, excluding petrol and diesel, at 2.9 per cent.

THE NEW OUTLOOK

* Governor Alan Bollard is expected to leave the OCR at 2.5 per cent on Thursday, but he is likely to drop the "expectation" that it will be the latter part of next year before it starts to rise.

* Financial markets see rates 2 full percentage points higher by then - an exceptionally wide credibility gap.

* But Bollard will be wary of going too far towards endorsing market pricing, if only for fear of sending the dollar even higher.