By Brian Fallow
WELLINGTON - Unfasten your seat belts, says the Bank of New Zealand, it could be some time before financial markets get exciting again.
"In the next couple of months, the next couple of quarters even, interest rates are not going anywhere, and on the currency side that is true as well," BNZ economist Peter Jolly said.
After the giddy volatility of the past it would take a little while for the New Zealand market to get altogether used to the idea that interest rates don't have to be either rising or falling, that they could be steady, he said.
Dampening down volatility in short-term interest rates is one of the main reasons the Reserve Bank abandoned the monetary conditions index as its operational target in favour of an official cash rate.
Recent economic data, including the December GDP out-turn, have been consistent with the moderate growth rates forecast by the Reserve Bank and the markets for the next two years. A better-than-expected balance of payments number shaved some of the risk premium off bond yields.
"From an interest rate and New Zealand dollar perspective, those pieces of news were as good as could have been hoped for, suggesting the Reserve Bank will sit on its hands for at least the next quarter and that this period of relative stability for New Zealand financial markets will continue," Mr Jolly said.
In the months ahead the markets might come to question whether the economy could manage a sustainable domestic-led recovery, and whether the current account deficit could continue to improve in an environment of weak commodity prices and anaemic world growth.
But, if anything, those factors would merely prolong the current period of low and stable exchange and short-term interest rates.
The BNZ view is that recently-announced increases in local body rates and retail electricity prices, combined with the firming of crude oil price, will generate a blip in inflation over the next two quarters, but that it is unlikely to be accompanied by generalised inflation pressures and the Reserve Bank will accordingly "look through" it and keep the official cash rate unchanged for most of the year.
The debt market is pricing in too much of a tightening in interest rates this year, Mr Jolly believes. "With forces on the economy fairly evenly balanced at present and consequently few inflationary pressures it is possible to see this present period of stable interest rates extending for some time. The market's current pricing for the cash rate to rise 50 basis points by year end does not seem to reflect how balanced the outlook is," Mr Jolly said.
"Although it is not our forecast, it is not inconceivable the Reserve Bank might even have to cut interest rates this year." Economists at the BNZ's parent, National Australia Bank, expect Australian central bank to be to be cutting rates later this year. "It is not plausible at all to suggest New Zealand will be raising them at the same time. There is every reason to expect the two economies to move much more closely [in step] in the future," Mr Jolly said.
Although a move of 50 basis points by the end of the year appeared modest when rates had moved more than 10 times that much over the past year, under the new regime it represented two tightenings by the Reserve Bank, he said.
As for the exchange rate, investors looking at New Zealand were generally looking at Australia at the same time.
"They are looking at this part of the world because our currencies fell rapidly as the Asian crisis unfolded and world growth slowed, and it seems quite reasonable they will be the first to recover should Asia become a lot brighter."
Already both the New Zealand and Australian dollars had done pretty well this year, he said. For investors looking to this part of the world to take a punt on world growth, Australia looked like a better bet than New Zealand, he said.
"They have a lower current account deficit [as a percentage of GDP] and they now have higher short-term interest rates."
Another economist who thinks the market is pricing in an excessive rise in interest rates is Bankers Trust's David Plank. "The market is obsessed with fighting the last cycle and avoiding the mistakes made in 1993/94 when monetary conditions were kept too loose for too long."
Markets settle down as interest rates fall off the rollercoaster
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