Rates to rise as Bollard plays belated catch-up

Alan Bollard

Reserve Bank Governor Alan Bollard will fire two missiles this morning: raising the official cash rate and talking tough enough to scare people into thinking there may be more to come.

"Unlike last year he is not only raising interest rates but delivering commentary, which is putting the fear of God into everybody," said Bank of New Zealand chief economist Tony Alexander.

"He has to scare people. A key route to slower growth [and less inflation] is to get people despondent about their profits and their jobs. This is what he didn't do last year and now he has to play catch-up.

"The major cost of that catch-up is being borne first of all by exporters because of the effect on the currency. But it will be borne by the rest of the economy - housing, retail spending - next year when higher fixed mortgage rates feed through, when the effects of the export downturn are more widely felt, and when the squeeze on profits feeds through to redundancies."

Bollard is expected to lift the official cash rate by 25 basis points to 7.25 per cent. Some economists see a chance he will raise the rate to 7.5 per cent.

In the key inflationary hotspot, the housing market, most borrowers are impervious because they have locked in fixed mortgage rates; about 80 per cent of mortgage debt is at fixed rates.

But the rise will still affect the other 20 per cent of home loans as well as pushing up business borrowing costs and - by underpinning the exchange rate - inflicting more pain on the export sector and those who compete with imports.

Alexander expects a hard landing in the second half of next year.

"A hard landing means it's bad, but it's not a recession. It means growth going maybe below 1 per cent and a lot of worry and despondency. A 'New Zealand hard landing' is everybody talking about going to Australia."

Westpac chief economist Brendan O'Donovan said monetary conditions - the exchange rate as well as interest rates - had been too tight for some time and areas of the economy were already in recession, including tourism, horticulture, fishing, forestry and manufacturing.

"Businesses in general have spent the last six months feeling very pessimistic, long enough to start affecting investment and hiring plans."

ASB Bank chief economist Anthony Byett said today's rate increase would not in itself be enough to cool the housing market.

"But we will also see continued upward pressure on fixed rates for some months yet, because international interest rates I suspect will go higher and a lot of fixed rate loans will need to be refinanced next year."

Overseas retail investors, especially in Japan, had readily financed banks' fixed rate loans over the past year or two.

"But it would be a brave person who would suggest they will just roll over their funding over the next 12 or 18 months.

"I suspect we will have to have relatively high fixed rates to attract that sort of money."

ANZ National Bank chief economist John McDermott said the economy was at a vulnerable stage of its cycle.

Some of the factors preceding the last two recessions in 1998 and 1991 were also present now: the currency was high, monetary policy tight, the current account deficit unsustainable, the housing market overvalued and inflation problematic.

"These by themselves did not instigate recessions but they left the economy vulnerable to the shocks that followed." .

In 1998, it was the Asian crisis and drought; in 1991, a global recession and the mother-of-all budgets.

And this time? "Well, we have one catalyst in the form of permanently higher oil prices. Add another one or two ingredients and the recipe for a recession could be complete."