But for the latest upsurge in house prices, the Reserve Bank would probably have made another cut in the official cash rate yesterday. It needs to keep its interest rates in line with those overseas so that the dollar's exchange rate does not rise and diminish export returns for farmers and other productive industries. The governor, Graeme Wheeler, conceded that the exchange rate is already "higher than appropriate" with dairy and other commodity export prices low at the moment. The governor's survey of the international economy was almost entirely an argument for another reduction in the official cash rate after his unexpected cut last month.

The outlook for global growth had deteriorated, he said. Monetary policy in most leading economies remains "extremely accommodative", meaning base interests are near zero, and even negative in some countries. In other words, banks in those places are charging people for depositing money with them and paying people to borrow money. This follows the failure of "quantitative easing" (printing more money) to lift the economies of Europe and Japan out of the doldrums they have been in since the global financial crisis, now more than seven years ago.

New Zealand and Australia have not used quantitative easing and, heaven forbid, will not let interest rates go below zero either. They only reason for New Zealand to reduce interest rates to that degree, besides exchange rate considerations, is that inflation remains lower than the target band the Government has given the governor. Finance Minister Bill English is supposed to demand explanations for this "failure" and has made the odd comment in this direction.

The target is 1-3 per cent inflation because if it goes below 1 per cent we are supposedly at risk of "deflation", a disease unknown to us but not to Japan. It is said to depress economic activity because people sense their money will buy more tomorrow than it does today and so reduce their spending. There is no sense that this is about to happen here, although inflation is running below 1 per cent. The governor sets interest rates not on current inflation but on the expected rate two years ahead. Yesterday he noted "a material decline in short-term expectations" though "long-term" expectations, he insisted, remained "well anchored at 2 per cent".


In other words, it is anyone's guess. The risk of general price deflation is clearly much less of a worry to the Reserve Bank than is the return of house price inflation. The lending restrictions imposed on the Auckland market by the bank in November helped to slow the rate of price rises over the summer but the bonfire returned in March. It appears the main effect of the Auckland lending restrictions was to send speculative investment to other cities and towns that are beginning to see prices rising out of reach of those who do not already own a home.

Low interest rates are already feeding speculative investment. After the failure of loan-to-value restrictions, the governor could not have lowered rates further yesterday. The bank and the Government need new solutions to the economic damage being done by this raging house market.

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