Squeeze coming to end, predict economists

The Reserve Bank's interest rate rise yesterday is being seen by economists and the money markets as probably the last for this cycle.

As expected, Governor Alan Bollard lifted the official cash rate 25 basis points to 7.25 per cent.

Confidence that this is the end of the tightening is largely based on mounting evidence that the economy is slowing, but the view gained more traction yesterday when Bollard acknowledged the risk of a harder landing next year if domestic demand cools faster than the bank expects.

The markets reacted to what they saw as a softening of the bank's hawkish stance not only by selling the kiwi dollar but shaving 7 to 8 points off the wholesale interest rates from which fixed-rate mortgages are priced.

But the overall tenor of the monetary policy statement was stern and a tightening bias remains in place.

"Whether further tightening is needed will depend on the extent to which housing and demand pressures show signs of moderating over the months ahead," the bank said.

It sees inflation remaining at roughly its current level of 3.4 per cent until the middle of next year, and staying close to the top of the bank's 1 to 3 per cent target zone until the end of 2007.

Westpac chief economist Brendan O'Donovan said he struggled to reconcile that with the Reserve Bank's forecast that growth in private consumption - the lion's share of the economy - would fall to zero over the same period.

The Reserve's forecast slowdown is based partly on factors already in place - dwindling immigration, declining terms of trade and the impact of the high dollar - and partly on its expectation that the housing market will run out of steam.

It expects house prices to fall, though not far, by the end of next year.

That expectation is based on the lagged effects of nine cash-rate rises in the past two years and the recent rise in world interest rates, which are now reinforcing, where once they offset, local monetary policy.

The bank also takes comfort from the Australian and British housing booms, which began before ours and are now over, triggering declines in consumer spending growth.

"Our analysis suggests house prices have a bigger influence on household spending than they do in Australia or the UK. New Zealanders have consumed more out of housing wealth gains than Australians or the British, so a fall in house price inflation can be expected to have a larger effect in New Zealand."

But the statement makes clear the bank will need to see evidence of a slowdown before further interest rate tightening can be ruled out.

Some economists saw the talk of a possible hard landing as a tactical mistake on the bank's part by turning the markets' attention to the prospects of an easing.

The markets dialled back the odds of another rate rise in January from about 50:50 to one in four. Two-year swap rates, a key source of funding for fixed-rate mortgages, fell 7 or 8 points.

"Just when it had businesses, financial markets and consumers alike fearful that interest rates would continue skyward, the bank made the same mistake it has several times in the past and simply threw in the towel," said Bank of New Zealand economist Stephen Toplis.

But the Reserve Bank reckons the bigger picture is that the 40 per cent of fixed-rate borrowers whose mortgages come up for repricing within a year will still face hefty rate rises - at least 60 or 70 basis points.

ASB bank chief economist Anthony Byett said home loan approvals had eased in recent weeks, but that had happened before and been followed by a rebound.

"The Reserve Bank may have to move again."

 

From the Reserve Bank's crystal ball

* Inflation stays around 3.5 per cent until mid-2006 and remains in the top quarter of the bank's target band for 18 months after that, giving it "no headroom".

* Economic growth slows to 2 per cent next year and 1.5 per cent in 2007, with spending and residential building weak.

* The current account deficit goes from bad (8 per cent of GDP ) to worse (over 9 per cent) by late next year.

* House price inflation, now 15 per cent, falls to zero. Prices even go backwards, briefly, by 2007.

* The average mortgage rate homeowners are paying tops 8 per cent next year then flattens off.

* Jobs growth dries up and the unemployment rate heads back towards 5 per cent.