Prospect of cash rate cut dwindles

The financial markets see almost no chance that Reserve Bank Governor Alan Bollard will lower the official cash rate on Thursday and have pushed back their collective view of when he will start to cut.

A Reuters poll of 14 economic forecasters on Friday rated it 99 per cent probable that the OCR would remain at 7.25 per cent - the second highest in the OECD after Iceland - after this week's review.

Since the previous poll on April 7, two of the big banks, ANZ National and Westpac, have pushed back their expectations of when Bollard will start to ease. The Bank of New Zealand and ASB have long been in the later-rather-than-sooner camp.

The markets now see about a 50:50 chance the easing will commence in September and are pricing in half a percentage point cut by year end.

Responding to the same flow of economic data the foreign exchange market has this month retraced about a third of the kiwi dollar's fall since the start of the year.

And the two-year swap rate, a key source of funding for fixed-rate mortgages, has risen to 6.94 per cent from 6.78 per cent three weeks ago.

All this is despite the fact that since the Reserve Bank's monetary policy statement in March we have learnt that the economy shrank 0.1 per cent in the December 2005 quarter and the Institute of Economic Research's quarterly survey of business opinion found firms reporting levels of activity consistent with another negative quarter in March - a technical recession.

But ANZ National Bank chief economist Cameron Bagrie said higher inflation rather than weaker growth represented the greater risk to the economy at present. True, firms' profit margins were under pressure, he said, and the response was more likely to be cutting back on employment and investment rather than generalised inflation. And higher petrol prices would speed households reining in spending and borrowing.

But higher petrol prices would also push inflation in the June quarter over 1 per cent, taking the annual rate to 3.6 per cent, and it was likely to stay above 3 per cent into next year.

"While petrol prices are a one-off that the Reserve Bank technically should look through, the potential for these increases to spill into more generalised inflation pressure is a risk it cannot ignore," Bagrie said.

Keeping inflation expectations well anchored was the bank's primary aim and would keep it talking tough.

Bollard said in March he did not expect to be in a position to ease monetary policy this year. "Any earlier easing would require a more rapid reduction in domestic inflation pressures than the substantial slowing already assumed in our projections."

And those assumptions included an exchange rate significantly higher than has eventuated. Even with the currency's rebound this month it is 5 per cent lower on a trade-weighted basis than the average level the bank assumed for the first half of this year.

Monetary conditions have therefore eased significantly already and in a way that benefits the hard-pressed export and import-competing sectors, as the bank would wish.

Meanwhile, the most recent data on consumer spending and the housing market suggest the slowdown in the domestic economy may not be as rapid as had been thought.

Retail sales jumped 1.9 per cent in February after flat-lining over the previous two months.

House sales last month jumped 27 per cent on February, or 7.6 per cent seasonally adjusted, while the time taken to sell a property fell from 37 to 33 days and the national median house price passed $300,000 for the first time.

Such figures could inflame fears at the Reserve Bank that the housing market could get a "third wind".

But Goldman Sachs JB Were economist Shamubeel Eaqub points out that sales in the first three months of this year were 11.7 per cent lower than in the same period last year.

And the average house price last month was only 7.7 per cent higher than in March last year, the lowest annual rate of house price inflation for three years.

"On balance," said BNZ economist Craig Ebert, "we believe the Governor is likely to reiterate the conclusions of the March monetary policy statement - that is, there is little reason to expect an OCR cut before early next year."