Bollard stays his hand but September rate rise looms

Alan Bollard has an eye on the high dollar. Photo / Mark Mitchell

Interest rates are set to rise half a percentage point, most likely in September, after Reserve Bank Governor Alan Bollard said yesterday he saw little need for the "insurance" rate cut he made after the February earthquake to remain in place much longer.

The message was, as ever, conditional, specifically on the risks posed by fragile global financial markets receding and on the New Zealand economy continuing to recover.

Bollard cut the official cash rate 50 basis points to 2.5 per cent on March 10, to bolster confidence after the Christchurch quake.

Sentiment surveys, including Wednesday's very upbeat National Bank Business Outlook, and the hard data on growth and inflation indicate the broader economy has shrugged off the quake and that there was more momentum in the economy than forecasters had seen.

Beyond the reversal of March's cut, which most market economists expect to happen in one go in September, the need for further interest rate rises would depend in large measure on whether the dollar remains at its current very high level.

"If this persists it is likely to reduce the need for further OCR increases in the short term," Bollard said.

He acknowledged the positive surprises in the growth data since the bank last reviewed rates in June but in the next breath noted the fragility in global financial markets, rattled by uncertainty around the US Government's debt ceiling.

It poses a risk to New Zealand's trading partners and to the strong export prices that have helped get the recovery back on track.

Bollard's comments on inflation amounted to a plea to wage and price-setters to ignore the headline rate of 5.3 per cent, which still includes the effects of last October's GST increase, and focus instead on the underlying inflation rate, which the bank estimates to be below 2.5 per cent.

But BNZ economist Stephen Toplis, an inflation hawk, thinks the Reserve Bank is pulling its punches on inflation and that it is a mistake to do so.

Underlying inflation of 2.5 per cent was not low when the economy was barely growing (1.4 per cent in the year ended March) and when the currency was dramatically appreciating, Toplis said. "What happens if the rate of appreciation slows and the economy has built up a head of steam?"

In the last tightening cycle the Reserve Bank had had a propensity to raise rates but soften the blow by saying that would probably be enough.

"It doesn't scare people. It doesn't change their behaviour.

"So in the end you may have to raise rates higher than if you had scared them in the first place," he said.

But Deutsche Bank chief economist Darren Gibbs said most of the inflation pressure was coming from offshore sources like global oil and food prices, which the central bank could do nothing about, rather than excess demand in the economy.

No amount of monetary policy tightening was going to get oil companies to cut their petrol prices, he said, or prevent high export commodity prices from flowing through to the price of food on supermarket shelves.

Truly domestic inflation looked very subdued, Gibbs said.

"Had it been me, I would have been content to spend a few more months with rates around where they are today," Gibbs said.

"Central banks know very well how to slow economies that are rampant. The difficulty, when rates are already at low levels, is in restarting economies when confidence tanks."