By BRIAN FALLOW
WELLINGTON - The Reserve Bank raised the official cash rate from 4.5 to 5 per cent yesterday, as expected, and foreshadowed rises of 1.5 percentage points over the next two years.
The bank's no-surprises monetary policy statement drew a muted reaction from financial markets.
It is projecting a more aggressive track for interest rates than it did in its last monetary policy statement in August, but that reflects a weaker-than-expected dollar.
The bank does not expect that weakness to persist, and it is counting on a 10 per cent rise in the exchange rate over the next two years, in trade-weighted index terms, to do much of the tightening work.
It expects the dollar to strengthen in the new year as a buoyant world economy flows through to more exports and better commodity prices, improving the trade balance and taking the edge off current account concerns.
By then, the dampening effect of political uncertainty and Y2K should have evaporated as well.
But the bank warns that if the currency weakness persists and is not well justified by external circumstances, then interest rates may have to rise faster.
The tightening track, which implies another 50 basis-point rise in March, is based on a robust growth outlook.
Gross domestic product growth is forecast to pick up from 2.6 per cent in the March year to about 4 per cent for the next two years.
At that rate the slack in the economy will be taken up during the course of next year, reducing the restraint on inflationary pressures.
The bank expects inflation to peak at 2.5 per cent in the first half of next year, with higher oil prices the main culprit.
While it expects higher fuel prices to flow through to freight costs and airfares, at this stage it does not expect significant "second-round" effects on wages and general inflation expectations.
But it identifies the chance that it is wrong about that as one of the main risks to its forecasts.
Deutsche Bank chief economist Ulf Schoefisch reckons the Reserve Bank is being optimistic about labour costs.
While it refers to a tightening labour market, the bank forecasts wage inflation to fall to 1.9 per cent in the short-term and then strengthen to only 2.4 per cent next year.
Mr Schoefisch says this outlook is accompanied by the assumption of a recovery in productivity growth to 2.6 per cent in 2000-01.
"That level is high by New Zealand standards and has not been achieved over the past 10 years."
WestpacTrust chief economist Bevan Graham expects interest rates to peak earlier and higher, with the official cash rate reaching 7 per cent by the first half of 2001.
ANZ Bank chief economist Bernard Hodgetts says: "It will be a very modest cycle compared with what we are used to, with retail rates staying comfortably within single digits."
Governor starts slow squeeze on inflation
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