US hiccup puts cloud over recovery

The economic recovery may be more drawn out than was expected and there are downside risks we don't really want to contemplate.
In the last week, wholesale and swap rates have fallen as financial markets, here and overseas, react negatively to economic data that is not as robust as was expected.
The primary driver has been the disappointing data emerging from the US economy which pushed rates lower there and extended the likely starting point of increasing interest rates to perhaps mid-2011 at the earliest.
As someone said some time ago: "The road to recovery could probably be likened to a bathtub with waves in it." It has certainly been an up and down ride so far.
In New Zealand, the Reserve Bank is now making statements that open the door for a pause in increasing the official cash rate (OCR).
The bank is, of course, facing the opposing challenges of trying to stimulate growth while keeping inflation under control - within the 1 per cent to 3 per cent acceptable band.
If the bank goes too far too soon, it will potentially cut off any recovery at the knees. If it moves too late, then it can really be difficult to pull back the momentum, and hence cause problems controlling inflation down the track.
Every three months, the Reserve Bank issues its monetary policy statement which fully updates the market - and, at the same time, allows for the six-weekly review of the OCR.
The next date is September 16 and the market is currently pricing in a 38 per cent chance of an increase in the OCR, and it will be interesting to see how far down the Reserve Bank reviews its projections.
The market is currently pricing in a OCR peak of about 4 per cent and that is close to 2 per cent less than the bank was predicting not that long ago.
For several weeks now, I have suggested that a pause in the increasing cycle was warranted due to several factors - low or reducing activity in the domestic, retail, small/medium business and housing sectors, worsening employment figures, a high NZ dollar, low net migration and significantly lower dairy prices.
Added to that, there is the GST increase in October and, while that is offset to a degree by lower tax rates, the cost to the household is likely to exceed the benefits.
All-in-all, the pressure is currently coming off inflation.
The Reserve Bank does not want to see a round of wage increases in response to the GST increase as lower tax rates are supposed to be compensating for that.
Also, it would be shortsighted for everyone to have a big spend-up prior to the GST rise on October 1 as that would push up retail data which would back the case for an increased OCR (to wind back activity).
While borrowers view the recent reductions in fixed interest rates as a real positive, they must also realise that the falls reflect the state of the economy.
Variable rates are getting closer to fixed terms of up to 18 months and two years.
The benefit of staying on a variable rate is being eroded. For the banks/lenders where a reasonable margin still exists between the variable and medium-term fixed rates, there appears to be no urgency to move to a fixed term - unless there is a strong desire for certainty for all or part of your interest rate exposure.
Saying that, it is still necessary to keep a close eye on economic data, especially out of the US. When that improves, the medium-term fixed rates are likely to start easing up again here.
Brian Berry is a director of Rothbury Financial Services, based in Tauranga. He can be contacted on: phone 0800 33 34 35, fax 07-5790666 or email brian@rothbury.net.nz