Markets discount rate rise for now

ASB chief economist Nick Tuffley. Photo / Northern Advocate

Financial markets expect a "so far, so good" monetary policy statement from the Reserve Bank on Thursday which reaffirms its intention to start raising the official cash rate around the middle of the year.

Since late last year a flow of soft economic data has left the markets a lot less aggressive about when the start of the tightening cycle would begin.

They have now largely discounted an OCR rise from its present historic low of 2.5 per cent until after the Budget on May 20.

A June start is the favoured option, with a steady stream of rises at every six-weekly opportunity thereafter. By this time next year the OCR is expected to be 3.75 or 4 per cent, according to Credit Suisse's swaps-based indicator.

"The Reserve Bank is likely to be relatively happy with current market pricing and would be reluctant to rock the boat significantly," ASB chief economist Nick Tuffley said.

He expects a similar statement to January's, if slightly more cautious.

The housing market was running out of puff, Tuffley said, with a fall in house sales, a rebound in the average number of days it takes a property to sell and signs of more houses being listed for sale.

Recent increases in mortgage rates and the expectation of more to come would be contributing to cooler demand, along with uncertainty about potential tax changes affecting property investors.

The resulting slowing in housing credit growth would be of comfort to the Reserve Bank, Tuffley said.

Consumer credit growth is also weak - down 4.1 per cent in January compared with a year earlier - as people remain wary of debt-financed spending when the labour market is so weak.

The bank had expected an unemployment rate of 6.6 per cent for December 2009; in fact it jumped to 7.3 per cent, the main surprise being in the number of job seekers, rather than the number of jobs.

Deutsche Bank chief economist Darren Gibbs said a higher level of labour force participation could be interpreted as a positive development - people felt encouraged to look for work despite a lack of net job creation.

"[But] it still implies greater downward pressure on wage and salary growth than the Reserve Bank had hitherto been forecasting," he said.

On the international front, while there had been a lot of focus on potential sovereign debt problems in Europe, consensus growth forecasts for New Zealand's trading partners had in fact edged a little higher in recent months, reflecting a stronger outlook for Australia and Asia, Gibbs said.

Export commodity prices, as captured by ANZ's commodity price index, have risen - despite recent weakness in the dairy sector - to be just short of their mid-2008 highs in both world price and New Zealand dollar terms.

Meanwhile exporters of manufactured goods stand to benefit from an exchange rate with the Australian dollar which has recently dropped to its lowest since November 2000.

"On balance we think the Reserve Bank's central view of the outlook for the real economy will have remained broadly as it was in January and December, with a slightly stronger outlook for the external sector balanced by a slightly weaker outlook for the domestic economy - and change in the mix that the bank will doubtless welcome," Gibbs said.

Westpac chief economist Brendan O'Donovan said the near-term inflation outlook was not as benign as the Reserve Bank hoped.

"Higher food prices, higher fuel prices, rising car prices, tertiary fee increases, higher pricing intentions and the weaker exchange rate all point to March quarter inflation of around 0.9 per cent, compared to the bank's forecast of 0.1 per cent."

And that is before the impact of the emissions trading scheme on energy and transport fuel prices from July 1, and the foreshadowed increase in the GST rate from 12.5 to 15 per cent, which would raise the consumers price index by 2 per cent.

While the Reserve Bank is likely to "look through" a near-term jump in inflation, it will be conscious that longer-term inflation expectations remain stubbornly high.

The last survey of business sentiment found that firms expect inflation to be 2.7 per cent in two years time and expectations are only fractionally lower, 2.65 per cent, in the bank's own survey.