Brian Fallow: Bollard credibility on line in rate pledge

Don't get over-excited about talk of green shoots of recovery. We are not out of the woods yet.

That was the clear message from Reserve Bank Governor Alan Bollard yesterday when he cut the official cash rate to 2.5 per cent, left the door open for more and said he expected to keep it this low or lower until the latter part of next year.

He acknowledged tentative signs world financial markets are stabilising, but warned the situation remains fragile. And while he expects the New Zealand economy to start recovering late this year he was at pains to warn that it won't feel like that for quite a while.

House prices will keep falling for the rest of the year, he said, and unemployment will keep rising well into next year.

By cutting rates and being so explicit about how long he expects to keep them down he is sending a signal to borrowers that there is no hurry to fix mortgage rates.

He was dismayed by events in March when borrowers, believing interest rates were all set to rise, scrambled to lock in low rates, and in the process drove them higher.

"We were a little scared a month ago that there was a sudden euphoria sweeping through the housing market in a way that might lead people to think happy days are here again and plough back in as if nothing had changed. That is not the situation."

Dr Bollard also regards the rebound in the kiwi dollar over recent weeks as unwarranted.

One effect of saying he will keep rates low should be to make the currency less attractive to overseas investors looking to pocket the difference between New Zealand and, say, Japanese interest rates with little or no exchange rate risk.

By being so explicit about the outlook for the official cash rate he is taking a gamble with his credibility.

Eighteen months is a long time - consider how much the world has changed in the past 18 months.

He may yet have to eat his words.

At one point in his press conference yesterday Dr Bollard seemed to be rehearsing what he would say if it came to that, quoting the great British economist John Maynard Keynes who, when accused of shifting his position on something, said: "When the facts change, I change my mind. What do you do, sir?"