KEY POINTS:
Probably the only people really surprised by Reserve Bank Governor Alan Bollard's decision to raise the official cash rate by 25 basis points to 8 per cent were those economists, a majority in one survey, who thought he would hold fire. Perhaps they were lulled by his previous inclination to be patient when confronted by what they deemed to be inconclusive data. Perhaps they also played down the increasing fretfulness that has been part and parcel of his demeanour on the three occasions he has lifted interest rates this year.
The Governor must sometimes feel things are conspiring against him. In a world awash with cash, his inflation-fighting agenda has been bruised and battered by a resilient housing market, effervescent spending by debt-laden households, a tight labour market, weak productivity and a more stimulatory fiscal policy. To add to his woes, a surge in dairy prices had just delivered farmers what Dr Bollard described as a "shock" payout from Fonterra. This is estimated to give every dairy farmer a $120,000 income boost. Its impact not only sealed this rise, but has ongoing implications for rates, depending on whether farmers spend or invest their windfall.
The Governor has been criticised in the past for tightening monetary policy too late. In part, this may be an acknowledgment of the particular disadvantage that a rate rise inflicts on exporters, thanks to a higher exchange rate. But such caution often means only that larger, more traumatic, increases may be necessary later if inflation pressures fail to cool. Dr Bollard appears to have reached a point where he believes he can no longer dither. On balance, he is probably right. Indeed, further increases seem likely to be needed.
His action may also suggest an acknowledgment that, for the foreseeable future, interest rates are his only weapon - and that he must continue to raise these until he has secured victory over what one economist has described as the "bullet-proof generation". This group has never been through anything tougher than an economic downturn and has witnessed only soaring house prices. It has no recollection that these fell almost 38 per cent over six years in the 1970s. Thus, it has shown a cavalier disregard for Dr Bollard's many warnings about household spending. The Reserve Bank's action will catch many of its members out over the next 12 months, when nearly a third of fixed-rate mortgages come up for repricing.
The Governor's request for other tools to rein in the housing market has been embraced only insipidly by the Government. He has talked of enforcing existing capital gain tax rules to combat property speculation, and increasing the amount of capital that banks must set aside to cover their lending on housing. But this year's Budget delivered only limited spending to bolster Inland Revenue action against speculators. This is unlikely to have a drastic impact.
Dr Bollard seems, therefore, to be applying the common currency of central banks with a renewed urgency. He will have been cheered by a display of support from an unlikely but astute quarter, the Canterbury Manufacturing Association. This could not, however, disguise the fact that changed bank lending practices have made the official cash rate an increasingly ineffectual and ill-directed tool to fight inflationary pressures. Undeniably, businesses bear too significant a cost in collateral damage. But until the Government recognises these new circumstances and the greater difficulties facing the Reserve Bank, and supports the Governor more wholeheartedly, interest rates will remain the only option. Dr Bollard is right to apply them in a manner that will make a difference.
