Bollard holds fire on rates

Reserve Bank Governor Alan Bollard has kept his finger on the interest rate trigger as he faces rising inflation and heightened uncertainty about the price of oil and the policies of the next Government.

As expected, he left the official cash rate on hold at 6.75 per cent yesterday but said the risk of higher inflation in the medium term had increased.

He reiterated the warning in previous statements that further tightening may still prove necessary.

Bollard emphasised the twin uncertainties of oil prices and fiscal policy under the new Government, whichever party leads it.

Oil prices have risen by 20 per cent since the previous monetary policy statement in June.

Coming on top of inflation pressures already strong after several years of above average economic growth, the oil shock would push inflation to around 4 per cent in the first half of next year, the bank said.

Bollard said he would not react to something he could not influence, such as international oil prices.

But if people responded to higher petrol prices by demanding higher prices for their goods or services or labour, threatening persistent and generalised inflation, he would react.

The risk of such a spillover becomes greater the longer oil prices stay high and the sooner the dollar falls.

But the bank would also have to take account of the dampening effect of high petrol prices on economic activity, which is already slowing.

As a rough rule of thumb, the bank said, a 10 per cent rise in oil prices curbed economic growth by 0.1 per cent to 0.2 per cent after a year, and reduced inflation pressures accordingly.

As for the impact of the taxation and spending policies of the next Government, the bank said it would be wrong to second-guess Saturday's poll but had to acknowledge the likelihood of greater upward pressure on demand and inflation "regardless of the composition of the Government after the election".

Bollard said the bank had only done the "ballpark analysis needed to assess the broad level of risks".

It would need a lot more information, not yet available, to calculate the monetary policy impact.

It would be thinking about the timing of any increase in the fiscal stimulus - whether it took place at a time when the economy was still tight or coming off - and the extent to which households lifted spending in anticipation.

"We would need more detail on costing and funding and we would want to see the results of coalition negotiations."

But the oil price effect was far more significant than anything he was anticipating on the fiscal front.

"What we are looking at on the fiscal side is a risk, a mild to moderate risk, but nothing like the magnitude of the oil price effect."

Cuts likely next year

In spite of the Reserve Bank's hawkish tone, most market economists still expect it to start cutting interest rates next year.

* ANZ National Bank: "The next move in interest rates will be down but not until the second half of 2006. Oil prices will magnify the slowdown already being fostered by higher interest rates and the high dollar."

* ASB's Kate Skinner: "The drivers of a slowdown are in place. Our core view is the OCR will remain unchanged until mid-2006."

* BNZ's Stephen Toplis: "A further rate increase is a real risk. More important than that, rate cuts will remain some way off."

* Deutsche Bank's Ulf Schoefisch: "We don't believe the bank will tighten again. Pending the outcome of the election, we retain our call of a first easing step in March."

* First NZ Capital's Jason Wong: "We have pushed out the timing of the monetary policy easing to June and reduced the cumulative amount through 2006 to 75 basis points."

* UBS's Robin Clements: "The oil price spike raises the risk that the rate cut may have to be pushed out to the middle of the year."

* Westpac's Nick Tuffley: "We still expect the Reserve Bank to change its tune and cut rates in the first quarter of 2006."