Stand by for a rate hike - or two

Alan Bollard

Reserve Bank governor Alan Bollard will tighten the interest rate screws another quarter-point to 7 per cent on Thursday, economists almost universally expect.

"We also expect a strong warning from the Reserve Bank that more tightening may be required," said Bank of New Zealand chief economist Tony Alexander.

"Inflation is now above 3 per cent and in a way for the Reserve Bank the real fight now gets under way. This involves scaring people - businesses and unions - enough to get inflation expectations down below 3 per cent."

Inflation expectations have been creeping higher under the influence of higher petrol prices, and jumped to an average 3.13 per cent in the National Bank's latest business sentiment survey, from 2.96 per cent in August.

ASB Bank economist Kate Skinner said money market pricing implied that an increase in the official cash rate from 6.75 to 7 per cent on Thursday was a virtual certainty, and that there was about a 40 per cent chance of another rate hike on December 8.

The central bank's projections in its September monetary policy statement (MPS) pencilled in a higher interest track, with 90-day interest rate peaking at 7.3 per cent.

Since then the data had tended to confirm that the momentum of spending in the economy was still strong. The housing market in particular showed no convincing signs of cooling, Skinner said.

The pace of house sales compared with a year earlier continues to accelerate and although the September median house price was unchanged on August, it was still 16 per cent up on a year ago.

Household borrowing in August was 15 per cent higher than in August last year.

Some of that borrowing is used for consumer spending and not just house purchases.

Bollard warned in a speech this month that a debt-financed spending boom had pushed the current account deficit - a measure of New Zealand's transactions with the rest of the world - to unsustainable levels and had made his task of keeping inflation in the 1 to 3 per cent band on average over the medium term "particularly challenging".

He also warned that the likelihood of a more expansionary fiscal policy on the Government's part would make both those things worse.

Since then the outcome of Government-forming horse trading has been announced.

The deals include a lift in New Zealand superannuation's relativity to the average wage, phased increases in the minimum wage and at least the possibility of company tax cuts and the scrapping of the carbon tax.

"We estimate the fiscal impulse will be around 1.2 per cent of GDP in the 2006/07 fiscal year," said Westpac chief economist Brendan O'Donovan. The September MPS had assumed a boost of just under 1 per cent.

O'Donovan thinks Bollard will hike rates on Thursday, but that he should not.

The governor should be patient and allow his previous rate hikes - seven since the start of last year - time to work, he said.

"Monetary policy takes a long time to have its effect, particularly in New Zealand with the preponderance of fixed rate mortgages."

As fixed rate mortgages were reset at higher rates and higher petrol prices squeezed spending on other things, domestic demand had begun to slow in the past six months.

Overheated economy

* Household borrowing in August was 15 per cent higher than in August last year.

* September's median house price was up 16 per cent from a year ago.

* Inflation rose to 3.4% in the 12 months to September, from 2.8% three months earlier