OCR to rise as soon as September

Reserve Bank Governor Alan Bollard announcing last month's decision to keep the OCR at 2.5pc. Photo / Mark Mitchell

Reserve Bank Governor Alan Bollard may hike the official cash rate by 50 basis (0.5 percentage) points as soon as September as he unwinds the emergency stimulus imposed after the Canterbury earthquakes, though any future hikes will be held back by a surging kiwi dollar.

Bollard indicated he will lift the OCR from its record low 2.5 per cent, where he held it today, saying the economy has rebounded faster than anticipated, and the emergency rate cut in March has "little need" to stay in place for much longer.

Economists including ASB's Nick Tuffley say a rate hike will probably come as early as September, with a 50 point hike to 3 per cent.

"New Zealand's economy is showing it's incredibly resilient and has bounced back from the earthquake," said Grant Hassell, head of fixed interest at AMP Capital Investors New Zealand. "It feels like Bollard will take back the 50 basis points" of emergency stimulus. "2.5 per cent is too low."

Any future rate hikes will be dependent on where the New Zealand dollar goes, which Bollard said "is acting as a drag on the New Zealand economy," and will "likely to reduce the need for further OCR increases in the short term."

A surging kiwi dollar has held back Bollard's favoured export-led recovery, topping a new post-float high 87.61 US cents in trading yesterday. That's kept a lid on foreign sales, with June trade data showed merchandise export receipts of $3.97 billion last month, more than $200 million less than expectations, for a monthly surplus of $230 million.

The kiwi dollar recently traded at 87.04 US cents, from 86.97 cents immediately before the announcement.

The strength in the currency has come from an improving domestic outlook and ongoing global weakness. Record high commodity prices, led by Asian demand for New Zealand's dairy products, have underpinned the local economic recovery and reinsurance money flowing helped stoked demand for the kiwi. At the same time, ongoing sovereign debt issues in the US and Europe have kept the greenback out of favour.

US debt is keeping global markets nervous, as partisan policymakers struggle to reach an agreement to lift America's US$14.3 trillion Federal government borrowing cap and avoid default and a credit rating downgrade.

Bollard said the uncertainty around the US government's debt ceiling and fragility in global financial markets, which has seen Greece get another bail-out from its European partners, highlights the downside risks to New Zealand's trading partner activity in the June monetary policy statement.

AMP Capital's Hassell said he doesn't expect the US debt talks to weigh on Bollard's decision to remove the extra stimulus.

New Zealand's economy grew at twice the pace of market expectations in the first three months of the year, expanding 0.8 per cent, while inflation sped away to an annual pace of 5.3 per cent in the second quarter.

Traders are betting Bollard will hike rates by 101 basis points in the next 12 months, according the Overnight Index Swap curve, and the two-year swap rate was little changed at 3.67 per cent after the announcement. The swap rate has increased about 25 basis points since the upbeat inflation and economic data.

Still, Bollard talked down the risk of inflation, saying the current spike was driven by the government's increase in consumption tax in October last year, when it lifted GST to 15 per cent.

"Wage and price setters should focus on underlying inflation, which is currently estimated to be below 2.5 per cent," Bollard said.

The central bank's inflation target is a band of between 1 per cent and 3 per cent over a medium term horizon.

Resilient business confidence is stoking inflationary pressures, with firms' pricing intentions and inflation expectations at elevated levels in this month's National Bank Business Outlook.

Companies have bounced back from the doldrums in March when the 6.3 magnitude earthquake in Christchurch killed 181 people and caused as much as $15 billion of damage.

See recent Reserve Bank changes to the Official Cash Rate here.