Bollard warns: I could do this again

Reserve Bank Governor Alan Bollard has refused to rule out a further increase in interest rates - maybe even as soon as his next Monetary Policy Statement in six weeks.

"Depending on the persistence of the current upturn (in economic activity), further tightening may be required", he warned today.

Economists were unsurprised by today's announcement.

"Going once really doesn't seem like it would have much of an overall impact on the economy, so we would be looking for them to go again within the next quarter or so," said Gareth Kiernan, senior economist at Infometrics Ltd.

All but one of the 16 forecasters in a Reuters poll had expected the central bank to raise rates after it warned at its previous policy review that a move was likely given concerns over medium-term inflation pressures.

The Reserve Bank today raised the official cash rate (OCR) 25 basis points to 7.5 per cent.

Despite pressure from a multitude of quarters to keep the OCR at 7.25 per cent, Dr Bollard decided the economy was overheating and needed cooling.

There had been strong indications from the central bank that the rate would be boosted in this morning's Monetary Policy Statement.

"Our concern is that the recent pick-up in housing and domestic demand may gain momentum, giving rise to a stronger cyclical upturn at a time when resources are already very stretched", Dr Bollard said.

"This could reverse the rebalancing of the economy that has been underway since late 2005 and present substantial risks to the medium-term inflation outlook.

"It would also increase the prospect of a more costly correction in the country's external deficit", he said.

The OCR, which affects mortgage and business lending rates, has been changed for the first time since December 2005.

The bank has struggled to get inflation under control despite a sluggish economy over the last two years and Dr Bollard signalled his frustration by revealing it, and other government agencies, are looking at other measures to support the OCR.

These include enforcing existing capital gains tax rules applying to housing investment and changes to bank capital adequacy requirements "to help moderate the amplifying effect of credit on the housing cycle".

Finance Minister Michael Cullen recently raised the possibility of a levy on mortgages, a suggestion that met wide opposition including from Prime Minister Helen Clark who called it a "dead duck".

Dr Bollard said the decision to hike rates at the quarterly review was aimed at reducing the risk of an unsustainable rebound in economic activity.

The recent volatility in world financial markets did not get a mention.

A return to a moderating trend in housing and domestic demand was essential to see a reduction in medium-term inflation pressures.

For the umpteenth time in recent quarters, the bank said it has been surprised by the rise in house prices.

Today, it said it had revised projections of house price inflation upwards.

"Further out, we assume that house price inflation will fall to more moderate levels, eventually reaching zero at the end of the forecast period (in 2010)."

Dr Bollard said house prices looked "stretched' and household "dissaving" -- where home owners are increasing debt against the rising value of their homes -- was unsustainable.

Economic activity had picked up in late 2006 and early 2007, supported by both the housing market and an expansionary fiscal policy.

The housing market had been supported by a continuing rapid expansion of mortgage credit at very low margins and strong growth in household incomes.

All this was leading to resource pressures and increasing the risk of a re-emerging inflation problem in the medium-term, Dr Bollard said.

"Our concern is that the recent pick-up in housing and domestic demand may gain momentum giving rise to a stronger cyclical upturn at a time when resources are already very stretched."

He said that could reverse economic rebalancing that had been under way since 2005.

It could also increase the prospect of a more costly correction in the country's external deficit, he added.

The bank has hiked interest rates despite projecting lower inflation than it did in its previous forecasts in December.

Annual inflation is projected at 2.3 per cent for the March 2007 and 2008 years against a projection of 2.7 per cent for those years in the December forecasts. The forecast for 2009 is unchanged at 2.7 per cent.

Dr Bollard said the recent sharp fall in inflation due to falling petrol petrol prices and the high exchange rate was temporary and understated the degree of persistent inflation in the economy.

Economic growth in the March 2007 year is seen at 1.8 per cent (previously 2.1), and next year will rise to 3.1 per cent (previously 2.7), before easing to 2.4 per cent (previously 2.5).

The bank estimated that the Government's Working for Families package has given a significant boost to families' disposable incomes -- around 6 per cent on average for eligible families.

The bank also forecasts the economy will get stimulus from the Government cutting the business tax rate to 30 per cent from 33 per cent.


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