Market picks no OCR rise till June

Reserve Bank governor Alan Bollard is not expected to make any change to the Official Cash Rate till June 2011. Photo / Mark Mitchell

The financial market now expects the Reserve Bank will not increase the official cash rate (OCR) from 3 to 3.25 per cent until June and predicts only one, or at the outside two, further hikes after that by this time next year.

This Thursday's monetary policy statement will be pored over for clues about how long the bank expects to keep the OCR on hold and the pace of the subsequent tightening.

Economists, as usual, are more cautious than the market, with most still expecting - though with less conviction - that governor Alan Bollard will raise the OCR again in March.

The starting point is weaker economic activity than the bank expected in its September forecasts, even though they represented a substantial downward revision of its view.

Gross domestic product grew just 0.2 per cent in the June quarter, when the bank had expected to see 0.9 per cent, and the Canterbury earthquake and other factors will have left its forecast 0.8 per cent for the September quarter stranded as well.

The labour market is looking better; the housing market, not so much.

"The weakness in housing demand highlights that households remain relatively cautious and underlying consumer demand remains subdued," ASB economist Jane Turner said.

"The Reserve Bank is likely to discount the recent strength in retail volumes, given it appears to be mostly driven by purchases of big-ticket items brought forward ahead of the GST increase."

Meanwhile, one region after another has suffered blows: the earthquake in Canterbury, the mining tragedy on the West Coast, Psa in the kiwifruit-growing regions, and now a looming risk of drought in the north.

On the international front export commodities are at an all-time high in world price terms, and even in New Zealand dollars are only 2.7 per cent off their all-time high last May.

How much good this does the wider economy, however, will depend on how much importance farmers attach to reducing debt, and how dry this summer proves to be.

Another external factor that is expected to keep the Reserve Bank in wary and watchful mode is the renewed gusts of anxiety shaking financial markets over sovereign debt issues among the weaker members of the euro zone.

"The most immediate risk to New Zealand would be a sharp rise in the risk premium that we pay for overseas funding, which in turn would imply a lower OCR track to reduce the impact on retail interest rates here," Westpac economist Michael Gordon said.

"Fortunately, the impact on our borrowing costs has been minimal - so far - compared to the sharp increase in May, when the concerns about Greece first escalated."

Standard and Poor's decision to put New Zealand's credit rating on a negative outlook, implying a one-in-three chance of a downgrade over the next couple of years, was a fresh reminder of the vulnerability arising from the country's high level of overseas debt.

Smoke signals from the Government indicate fiscal policy will turn contractionary next year, which would take some pressure off monetary policy.

On the positive side Deutsche Bank chief economist Darren Gibbs points to a pick-up in business sentiment over the past couple of months, at least as reflected in the National Bank's survey, with firms becoming more optimistic about the outlook for their own activity, hiring and capital spending.

"With actual growth in activity having underperformed what this survey would normally have suggested, the Reserve Bank is likely to treat this rebound in sentiment with some caution," he said.

But surveys of job vacancies have been improving and imports of capital equipment have picked up in recent months, Gibbs said.

And there are signs that the process of debt-shedding in the business sector may be coming to an end.

"Bank lending to the business sector rose on a three-month average basis in October, for the first time in 19 months," he said.

Nevertheless on balance Gibbs believes it will be June before the Reserve Bank raises the OCR again.