Brash tipped to lift interest rates

By BRIAN FALLOW

After a run of positive economic indicators some economists expect Reserve Bank Governor Don Brash to start raising interest rates again in May.

Employment growth and tourist arrivals in the December quarter were much better than expected, December retail figures were robust and the housing market has unambiguously turned the corner.

The statistics point to December having been significantly more buoyant than the Reserve Bank expected, says Deutsche Bank chief economist Ulf Schoefisch.

Moreover, sentiment indicators and anecdotal evidence, particularly relating to the housing market and tourism flows, suggest that those buoyant conditions have continued into the new year.

The global outlook is also improving, Mr Schoefisch says. Confidence indicators have continued to move up, Euroland appears to have passed the bottom of the cycle and American consumer demand continues to be stronger than expected.

He expects Dr Brash to start in May the process of taking back the full percentage point "insurance" cut in interest rates he made after the September 11 terrorist attacks in the United States.

Deutsche Bank expects Dr Brash to push the official cash rate (OCR) from 4.75 per cent now to 5.5 per cent by mid-August and 6.5 per cent by the middle of next year, or sooner if the dollar remains weak.

The futures market is also expecting to see a relatively aggressive Dr Brash.

Futures pricing implies the OCR will be raised to 5.25 per cent by June, with another 25 points in the September quarter.

Bank of New Zealand head of market economics Stephen Toplis rates the odds of a 25-point rise in rates in May as 60:40, and has the OCR at 6 per cent by early next year.

That reflects the BNZ's forecast that economic growth will accelerate from 2.5 per cent this year to 3.7 per cent next year, the period monetary policy moves now can influence. That rate is well above New Zealand's sustainable growth rate in recent years.

But the inflation outlook provides no reason to panic, Mr Toplis says.

Employment growth - though stronger than expected - has been matched by growth in the supply of labour, on the back of net migration inflows, so wage growth should ease.

In addition, the migration inflows boost the potential growth rate - the rate the economy can sustain without overheating.

"Assisted by migration inflows we believe growth in the working age population will rise from 0.7 per cent to almost 2 per cent," Mr Toplis said.

"That means that, other things being equal, the economy can grow over 1 per cent more than it could, without generating inflation."

Rural incomes also have yet to feel the effect of recent falls in commodity prices, and the exchange rate is higher than the Reserve Bank had assumed in its last forecasts.

ANZ chief economist David Drage believes Dr Brash will wait until August before applying the brakes.

He points out that much of the 2.1 per cent increase in retail sales volumes in the December quarter was driven by car sales. Strip them out and the increase was a more modest 0.8 per cent.

Job advertisements have fallen in four of the past five months. In January they were 16 per cent below their peak in July last year and 10 per cent below their level a year ago.

Surveys of firms' hiring intentions have shown an easing, another sign of a weakening labour market.

"Certainly the outlook for domestic economic activity in 2002 is favourable, with stronger inward net migration likely to continue to underpin retail spending and the housing market," Mr Drage said.

"But we would caution against expecting activity growth to continue to accelerate at the rate seen recently."