Rates to peak soon says bank

By BRIAN FALLOW


Economic growth has almost certainly peaked and interest rates may do the same soon, says Deutsche Bank.

But the peak in rates may prove to be a plateau, such is the strength of domestic inflation.

The economy grew 0.9 per cent on the June quarter, to be 5.7 per cent larger than in June last year.

But Deutsche Bank's fixed income strategist David Plank says that unless it grows 1.7 per cent or more in the current quarter - which seems unlikely - that is likely to be the peak of the annual growth cycle.

Since the Reserve Bank introduced the official cash rate five years ago turning points in the growth cycle have been followed by turning points in interest rates with a much shorter lag than in the 1990s.

"You can probably say that rates are pretty close to their peak, but it is hard to argue they are going to come down any time soon," Plank said.

The fly in the ointment is inflation. Non-tradeables inflation (inflation not influenced by international competition or the exchange rate) is running at a hot 5 per cent.

When it was last that high in the mid-1990s the Reserve Bank was standing on the brakes, with 90-day rates hitting 10 per cent despite a slowing economy.

Since then the bank is more confident that price-setters believe inflation will stay under control. And it has a mandate from the Government to be a gentler central bank, with a wider inflation target band and a focus on the medium term.

Even so, warns Plank, because growth has been running above trend for a prolonged period the bank may not react as quickly to a sharp downturn in activity as it did in 2000.

"It is possible - we won't know for a few years yet - that the bank has made a monumental policy error over the past few years by being too slow to tighten and allowing domestic inflation to get away on it."

Governor Alan Bollard eased last year when it looked like the world economy was in serious trouble.

"In hindsight - which is always 20:20 - that looks like an error. But it is hard to criticise them for doing it. The consequence is the boom NZ has enjoyed over the last 12 months and that is why we have a domestic inflation problem,"Plank said.

Deutsche Bank economists, like other forecasters, expect Bollard to raise the official cash rate again in October, to 6.5 per cent.

But they think that will be the last rate hike in this cycle.

Chief economist Ulf Schoefisch said the firming New Zealand dollar would achieve some of the additional tightening the Reserve Bank wanted, and evidence of a slowdown in growth was mounting:

"Net migration flows have eased significantly, housing turnover has fallen, house price inflation is close to zero, the lagged impact of rising interest rates is going to hit household spending, export commodity prices appear to have peaked, the New Zealand dollar is putting pressure on export competitiveness and the global growth cycle has plateaued."