Bollard keeps his club at ready

Alan Bollard

Reserve Bank Governor Alan Bollard has endorsed the widespread view he has finished raising interest rates.

Leaving the official cash rate steady at 7.25 per cent yesterday, he said he did not expect to have to raise it further in this cycle.

But in the next breath he added that the possibility could not be ruled out until he saw clear evidence of a sustained weakening of domestic demand.

"He has kept the club within reach," said ANZ National Bank chief economist John McDermott.

"He had a bob each way: We are at the top of the cycle - unless we have to go one more."

Economists said the language of the accompanying statement was less hawkish than in December which, in turn, had been softer than October.

But Bollard also sought to dampen market expectations of an early start to the easing cycle, saying that would risk reigniting spending and hence inflation pressures.

Deutsche Bank chief economist Darren Gibbs took that to rule out an easing in June or July as a few economist had been predicting.

"But we don't think this language quarrels with the consensus view of financial markets - and our view - that an easing cycle will most likely begin in September," Gibbs said.

He said the Reserve Bank was right to warn that inflation was likely to remain high over the next couple of years, well after excess demand in the economy had been eliminated, especially if the dollar fell as forecast.

"The scope for the bank to ease later this year, therefore, will depend on whether inflation expectations - which rose through 2005 - become significantly unhinged."

Bollard said it was of particular concern that inflation expectations remained uncomfortably high.

But First NZ Capital economist Jason Wong said expectations would moderate as actual inflation fell, as occurred every cycle.

Westpac chief economist Brendan O'Donovan said Bollard was underestimating the severity of the economic slowdown and risked amplifying the cycle rather than smoothing it. He expects the official cash rate to start being cut early in the September quarter or sooner if the dollar remains high.

McDermott expects the easing to start in October but to be rapid when it comes, with the OCR possibly reaching 5.5 per cent by the middle of next year.

"But first they will have to see actual inflation come back inside the [1 to 3 per cent] band, inflation expectations capped and come back a little and wage growth remain moderate.

"When that is in place they can stop thinking about inflation and start thinking about how to perk up the economy, which by then will have suffered quite a bit of damage," McDermott said.

The Bank of New Zealand thinks the first easing will be no earlier than December.

"The key to the Reserve Bank eventually easing will be a softening in the labour market," BNZ head of research Stephen Toplis said.

"This will require the unemployment rate to head higher in a sustained way.

"Leading indicators in the labour market are beginning to look a lot softer and anecdotal evidence of lay-offs is gathering by the day. So it may well be the bank gets the evidence it requires."

But Toplis said the central bank would not be happy with a recent easing in fixed mortgage rates on offer.

"Not only are mortgage rates being held down by declining swap rates but strong banking sector competition, as a big chunk of the nation's mortgage book rolls over this year will keep downward pressure on lending rates."