Markets punt on small rise in OCR to 3pc

Reserve Bank Governor Alan Bollard. Photo / Mark Mitchell

Financial markets regard it as virtually certain that the Reserve Bank will raise the official cash rate from 2.75 to 3 per cent on Thursday.

Governor Alan Bollard's announcement will be minutely examined, nonetheless, for signs that weaker-than-expected data on growth and inflation are inclining him towards a lower trajectory for interest rates, compared with the bank's June monetary policy statement.

"We think recent developments both at home and abroad mean the bank will now be leaning towards a slight downward revision to its upbeat outlook for economic activity, and a related slight downward adjustment to its pessimistic forecast for inflation," Deutsche Bank chief economist Darren Gibbs said.

March quarter gross domestic product growth came in at 0.6 per cent, which was not far short of the Reserve Bank's forecast of 0.8 per cent.

However, soft consumer spending suggested its estimate of 1.1 per cent growth in the June quarter was probably too optimistic, Gibbs said.

A lower starting point for economic activity implies it will take longer to take up the post-recession slack in the economy and less inflation pressure.

The housing market is subdued. Turnover is low and the Real Estate Institute's house price index is almost unchanged from where it was at the start of the year (though only 4 per cent off its peak in late 2007). Credit growth is weak to non-existent.

The net inflow of migrants has dwindled to a trickle - just 70 last month.

ASB chief economist Nick Tuffley said that although the Reserve Bank may be facing a sightly weaker housing market than it expected, it was likely to be comfortable with recent developments.

"For a long time, the bank has been looking for a rebalancing in growth away from the household sector and towards the export sector. Recent developments have been consistent with the recovery taking this form."

The fly in the butter dish, however, is that dairy prices have fallen for the past three months, including a 14 per cent decline in this month's auction.

"In addition to weaker dairy prices, a closer look at the Reserve Bank's trading partner GDP forecasts reveals a relatively optimistic view compared to Consensus Economics' survey," Tuffley said.

Inflation in the June quarter, and non-tradeables inflation, in particular, came in lower than the Reserve Bank, and almost every other forecaster, had expected.

The one-off impact of Government policies - notably the rise in the GST rate and tobacco excise, and the start of the emissions trading scheme - is expected to push inflation above 5 per cent over the year ahead.

That is only a problem for the Reserve Bank, and therefore for borrowers, if it results in a persistent rise in inflation expectations and wage inflation.

The biggest of the policy-related price increases, the rise in GST, will be offset by income tax cuts.

But to the extent that people still need pay increases to compensate for a higher cost of living, they may struggle in the context of a labour market which, while improving, is still weak.

Goldman Sachs JBWere economist Philip Borkin said: "It will be difficult for people to get it through in their wage negotiations, and we are starting to hear some anecdotes from retailers that they are considering not passing on the full GST hike because the demand backdrop is still soggy."

Overall, market economists expect Bollard to reiterate that at this point raising the OCR is an exercise in progressively removing the extraordinary level of monetary stimulus dispensed in response to the financial crisis - easing back on the accelerator rather than hitting the brakes.

They consider the data flow since he started that process on June 10 would only have changed the bank's view of the outlook at the margin, not fundamentally.

Financial market pricing, as reflected in Credit Suisse's swaps-based index, implies the OCR will be 4 per cent by this time next year, which would mean four more rises of 25 basis points after this week's.