Bernard Hickey: Leaving OCR at record low unthinkable

The Reserve Bank's moves will continue to exert downward pressure on house prices. Photo / Paul Estcourt

Alan Bollard has done the right thing, despite the calls from some exporters for more relief and the less than remote prospect of a financial market meltdown in Europe.

The prospect of inflation rising to 5.4 per cent by midway through next year and leaving the Official Cash Rate at a record low of 2.5 per cent is unthinkable.

Even though much of the spike is one off in nature (GST increase, ACC levies hiked and ETS costs imposed), Bollard is right to point out that a surge in export incomes and GDP growth of 3.5 per cent each year for the next couple of years will take plenty of slack out of the economy and increase price pressures.

Bollard is also getting plenty of help from friends, but they are not the usual friends in government.

This time the financial markets have pushed up longer term funding costs for the banks and the banks themselves are choosing (or being forced) to raise more funding from expensive local term deposits.

This means Bollard can afford to increase the OCR more slowly and not to such a high level as in the past.

This time around the RBNZ expects the 90 day bank bill rate to peak at around 6.1 per cent in late 2012, up from around 2.9 per cent now.

That would, in theory, increase floating mortgage rates from around 5.8 per cent now to around 9 per cent by then.

Term deposit rates are also likely to rise by as much if not more as the banks come under increasing pressure to raise funds locally.

The margin between retail term deposits and wholesale interest rates has risen in the last two years from around 50 basis points below wholesale rates to as much as 200 basis points above wholesale rates.
That would imply term deposit rates rise to well over 6 per cent by the end of 2012.

All this will continue to exert downward pressure on house prices, as the Reserve Bank forecast in its June quarter monetary policy statement. It has reduced its forecasts for house prices by around 2 per cent from its March quarter forecast and now expects nominal house prices to only just recover their price fall.

- Bernard Hickey