KEY POINTS:
According to Don Brash, the former Governor of the Reserve Bank, the quickest way to decrease the value of the dollar is to make it unambiguously clear that the bank will do whatever it takes to bring domestic inflation under control. That had not happened until yesterday. Fortunately, that situation has now been rectified. The lifting of the official cash rate to 8.25 per cent, the fourth rise since March, sends an unequivocal message. Much noise, largely of an extraneous nature, urged Alan Bollard, Dr Brash's successor, not to act. Fortunately, again, it was shunned.
The consolation for debt-laden householders facing mortgage rate increases is that the Governor indicated he expected this to be the top of the interest-rate cycle. This was because he saw early signs of New Zealanders moderating their borrowing habits. Most notably, Dr Bollard did not include the housing market among the factors - a boom in dairy prices, a tight labour market and increased food and fuel prices - that spurred the rate rise. Having identified the housing sector as the main driver of inflationary pressure, he appears willing to accept that tentative signs of cooling are the start of an accelerating trend, not merely the mark of a winter slowdown.
However, Dr Bollard's statement also contained a caution that people's demand for borrowing must continue to ease. "Provided they keep this up, and the pressure on resources continues to ease, we think the four successive OCR increases we have delivered will be sufficient to contain inflation," he said. Other inflationary pressures, on the immediate horizon and inherent in a much-increased payout to dairy farmers next year, make ongoing moderation imperative.
Dr Bollard also warned overseas investors yet again that the dollar is not sustainable in the medium term. The indication that the interest-rate cycle has peaked is likely, in itself, to temper their ardour. If, as the Governor suggests, inflationary pressure is being reined in, the scene is set for a sustained fall in the dollar, much to non-dairy exporters' relief.
The increase in the official cash rate is, of course, also notable in terms of the pressure applied on Dr Bollard. Most particularly, this came from Finance Minister Michael Cullen's repeated references to section 12 of the Reserve Bank Act. This gives the Government the power to order the bank to base its interest rate decisions on factors such as the strength of the dollar, rather than giving absolute priority to the fight against inflation. As had to be the case, Dr Bollard has demonstrated his independence, and reaffirmed a singular focus on inflation.
That does not mean, however, that Government action is not required. The pain for exporters has been exacerbated by the weak United States dollar, but as long as the factors that spur New Zealanders' infatuation with the housing market remain intact, there is the potential for a repeat of circumstances along the present lines. To prevent that, the Reserve Bank favours the enforcement of existing capital gains tax rules and changes to bank capital adequacies requirements. Consideration of this, and other potential pieces of ammunition, must be high on the Government's agenda.
Dr Bollard spent a long time trying to talk down the housing market and consumer spending. An opportunity to act last October, when many two-year loans expired, was squandered. Finally, the Governor has acknowledged that firm, sustained action is the only way to contain inflationary pressures. It is not a message that people want to hear, but it is one that, finally, appears to be being heeded. In time, all sectors of the economy will benefit.
