Rate rise bark first - then the bite

By BRIAN FALLOW economics editor

Reserve Bank Governor Don Brash is expected to bark but not bite in tomorrow's monetary policy statement, leaving the official cash rate unchanged but reinforcing expectations that it is only a matter of time before it is tightened.

A Reuters poll of economists at 12 banks and brokerages last week found seven expected Brash to wait until the next monetary policy statement in May before raising rates.

Only the ASB Bank thought he would move tomorrow and the other four, including ANZ and WestpacTrust, thought he would wait until August.

A more aggressive approach is prevalent in the dealing rooms, where 75 basis points of tightening by May have been priced in, reflecting a run of better news on the global economy and continued evidence of buoyant domestic activity.

But HSBC economist Grant Fitzner says that after copping flak for contributing to the last recession, Brash will not want to be seen as stomping on growth by lifting rates too high, too soon.

"And in any event, having cut interest rates by less than most other central banks during the downturn, the Reserve Bank doesn't need to lift rates as aggressively in the upturn," Fitzner says.

Deutsche Bank economist Darren Gibbs also believes issues of reputation will stay Brash's hand this week. "If he were to tighten this week people would expect [further] moves in April and May and we could find we had 75 points of tightening before any other central bank had got off the mark."

Waiting a couple of months, by which time evidence of the need to tighten should be compelling, would not make much difference to the economy, Gibbs says.

Other elements of overall monetary conditions have already tightened. Over the past fortnight, the New Zealand dollar has risen 1.5c against the US dollar and by 2.5 per cent to 52.6 on the trade-weighted index, a level the Reserve Bank had not expected to see for another two years.

Longer-term interest rates have risen to yields which imply the official cash rate, now 4.75 per cent, will peak above 7 per cent.

Deutsche Bank says the Reserve Bank is unlikely to want to trigger an even steeper yield curve through an early tightening move, considering the pace of the global recovery remains uncertain.

Bank of New Zealand economists say the reasons Brash gave for his last rate cut, in November, have dissipated, but they doubt he is "brave enough" to reverse the move yet.

They say the domestic economy has proved more robust and the global downturn has blown over more quickly than he expected.

WestpacTrust chief economist Adrian Orr says activity indicators in the United States and Europe show signs of improvement, but considerable risk remains.

In the US, debt levels are high and the corporate and household sectors fragile. Although a restocking cycle has begun, continuing growth in final demand is far from certain, Orr says. And Japan remains in a parlous state.

UBS Warburg chief economist Robin Clements says some of the consequences of the global slowdown are still filtering through, in weaker export demand.

"But the big picture is that the New Zealand economy is already operating at or above potential, with low unemployment and high capacity utilisation, and has core inflation of around 2.5 per cent.

"In these circumstances, and with the world economy on the mend, the insurance easings of late last year will need to be withdrawn."