Bank set to start hiking cash rate

Alan Bollard. Photo / Mark Mitchell

The Reserve Bank is widely expected to begin on Thursday to reverse the emergency interest rate cuts it made in 2008 in response to the global financial crisis.

Market economists in Reuters' most recent poll put the odds at two to one that Governor Alan Bollard would raise the official cash rate to 2.75 per cent from the historic low of 2.5 per cent where it has sat since April last year.

Money market pricing, as reflected in Credit Suisse's swaps-based indicator, puts the chances of a rate rise even higher at 80 per cent.

In a speech a month ago Bollard said the markets' expectation that the bank would begin raising the OCR around the middle of the year and continue to raise it in small steps for some time was "broadly in line with our current views".

Since then the outlook for the export sector has brightened, the labour market has improved and the Government has put up a Budget which, while disciplined in the medium term, is stimulatory and inflationary in the near term.

Consensus forecasts for GDP growth among New Zealand's trading partners have been revised upward to an above-trend 4 per cent this year and 3.8 per cent next year.

"New Zealand is benefiting from increasing penetration into the fast-growing developing Asian markets, as well as our close ties to Australia, another country benefiting from Asia's growth," Westpac economist Michael Gordon said.

Export commodity prices are at record highs, even when converted into New Zealand dollars. Fonterra's forecast payout for next season is strong and expected to boost confidence and spending in dairying regions.

Meanwhile the Reserve Bank's comments so far on perturbations in European financial markets over sovereign debt concerns have sounded watchful rather than concerned.

Releasing the bank's financial stability report on May 13, Bollard said events in Europe were "not currently affecting us very much" though they had "spilled over into bank financing markets a little bit". But while the international outlook is on balance encouraging, the domestic economy's recovery is, in Bollard's words a month ago, "much more fragile".

Even with the unexpectedly strong rise in employment recorded in the March quarter, unemployment remains high and wage growth weak.

It is not yet clear how far October's income tax cut will go in offsetting feeble growth in wages and salaries, rising mortgage rates and a surge above 5 per cent in the inflation rate.

Households are cautious, NZIER principal economist Shamubeel Eaqub said, as indicated by weak turnover in the housing market and stagnant retail sales in real per capita terms.

Bank lending to households is growing only slowly, while lending to business continues to shrink.

Eaqub questioned the need for Bollard to raise the cost of credit when in real terms credit is still contracting.

But Deutsche Bank chief economist Darren Gibbs does not think it is likely to cause the Reserve Bank to hold fire.

"We think the slow growth in household credit is something the Reserve Bank will welcome and be keen to see maintained as the economic recovery continues to play out.

"Meanwhile the weakness seen in business credit is, in our view, largely a function of the current position of the economic cycle. As the economy absorbs spare resources, growth in capital spending can be expected to resume and demand for credit will follow suit."