Bollard pumps up the volume

Alan Bollard

Reserve Bank Governor Alan Bollard left the official cash rate at 6.75 per cent yesterday but pumped up the volume on warnings the next move was more likely to be up than down.

"The accompanying statement was as hawkish as the Reserve Bank could get without actually raising rates," said ASB economist Kate Skinner.

Bollard said the outlook offered no scope for an easing in policy in the foreseeable future; six weeks ago the bank saw "little" scope for an easing.

He said the bank would be reviewing its forecasts, in particular the strength of the yet-to-be-felt effects of higher interest rates and the high exchange rate "to confirm whether further policy tightening is warranted at the June monetary policy statement".

Economists took the use of the word "confirm" to mean the bank was of a mind to twist the interest rate screw once more unless soft economic data between now and then persuaded it otherwise.

Several analysts said the sterner-than-expected message was directed at the financial markets, which had begun to price in some chance of a fall in interest rates before the end of the year.

Bollard's dilemma is that because of borrowers' preference for fixed-rate loans - 81 per cent of all mortgage debt was at fixed rates as at the end of February - it is taking longer than previously for the effects of increases in the official cash rate to be felt.

He has raised rates 1.75 percentage points since the start of last year but only about half of that has been felt by borrowers yet.

At the same time, the financial markets, which deliver the funding for those loans, have become more pre-emptive, focused on the next move in official interest rates.

Looking at such signs of slowdown as this week's collapse in business confidence, they expect the next move to be down and have begun to pull key wholesale interest rates lower. That threatens to undo the Reserve Bank's past rate hikes before they have had time to take effect.

Westpac chief economist Brendan O'Donovan said it left the bank with little choice but to talk tough.

"If they had an equivocal statement like they delivered in March - all about turning points and almost apologetic for the rate hike - then term rates, particularly the one and two-year rates where all the fixed-rate borrowing is happening, would have kept falling," he said.

Bollard's statement made no mention of the sharp fall in business confidence and mused that the recent soft economic growth figures could indicate capacity constraints rather than weakening aggregate demand.

If growth slows because the economy's capacity to produce more is constrained while demand is still strong, that is a recipe for inflation.

"We don't buy that hypothesis," O'Donovan said. "If it was supply constraints why haven't we seen a dramatic fall in inventory levels?"

He said the combination of weakening growth but strong inflation pressures was normal late in the economic cycle. Eventually, inflation would abate.

Deutsche Bank chief economist Ulf Schoefisch does not believe Bollard wants to raise interest rates further. "Significant pipeline pressure from the high dollar and past interest rate increases has yet to feed through into the economy and the global outlook has become less certain again.

"Falling business and consumer sentiment is a strong indication that demand growth will continue to ease and alleviate capacity pressure going forward."

The bank would be aware of the risk that further rate hikes at this stage of the cycle could push the economy to a hard landing.

But the Bank of New Zealand's head of market economics, Stephen Toplis, said: "The Reserve Bank is up against it."

The National Bank's business confidence survey this week showed declining growth expectations but not declining inflation expectations.

"It is not a done deal that they will go in June. But if they are going to move they are going to raise rates not cut them, and the chances of them raising rates are higher than most people are willing to accept," Toplis said.

"What might put them off is weakness in retail sales or the housing sector, a sharp increase in the currency, a higher-than-expected unemployment rate, lower-than-expected wage growth. One or all of those things."