Bollard makes 'toughest' call

Reserve Bank Governor Alan Bollard is selling yesterday's rise in the official cash rate as the stitch in time that is needed to avert tougher action later.

Bollard said the economy was near a turning point and the bank did not want to make the coming slowdown worse.

But failing to tackle inflationary pressures would bring the risk of tighter monetary policy later.

Bollard said raising the rate was the toughest monetary policy call he had made.

Pushing the rate from 6.5 per cent to 6.75 per cent helped the dollar to jump to a fresh post-float high yesterday of 74.49USc, before closing at 74.29USc.

Interest rates rose, too, with the 90-day bank bill rate hitting 7.03 per cent, up from Wednesday's 6.91 per cent.

The sharemarket tumbled by 1.3 per cent.

Deutsche Bank chief economist Ulf Schoefisch said ultimately the interest rate increase would not have much effect on the domestic economy.

"What it does is exacerbate the currency move and hit the wrong side of the economy" - in other words, exports.

Bollard said the principal factor driving the exchange rate was the weakness of the US dollar. It also reflected high commodity prices.

"We are going at the margin to see some suffering from the high dollar."

Westpac chief economist Brendan O'Donovan said world prices for dairy and meat exports were high, but they were only a minority of exports.

The forestry, fishing and tourism sectors did not have that comfort and nor did manufacturers.

Bank of New Zealand economist Stephen Toplis said that although, in the short term, the move might push the dollar higher and exporters would complain, it would also bring forward the slowdown in the domestic economy, which ultimately would bring the exchange rate down.

Keeping interest rates on hold risked keeping the exchange rate high for longer, he said.

ANZ National Bank economist Cameron Bagrie said the dollar's trend was still up, but when it turned it could fall quickly.

For the Reserve Bank, that raised the risk of rapidly rising prices for imported goods while domestic, non-tradables inflation was still high.

It could push inflation above 4 per cent.

The bank is forecasting that inflation will remain at 3 per cent, the top of its target band, all through this year and next year.

Bollard made it clear the risk that posed to inflation expectations, which have been inching higher, was the overriding consideration in his decision.

Commentators agree the rise increases the chances of a hard landing for the economy next year.

The bank expects growth to slow from 5 per cent this year to 3 per cent by next March and below 2 per cent the following year.

Given that, and the bank's expectations that house prices on average will fall next year, it was unnecessary to tighten the monetary screws further, O'Donovan said.

Bollard said the "window remained open" for another interest rate rise.

He said there was little scope for an easing in the foreseeable future and it would be "imprudent" to rule out further increases.

He was aware the kiwi was at high levels, but believed it was being driven by the low US dollar.

But ANZ National no longer expects Bollard to increase the rates again next month.

It does not think the data will be strong enough to justify such a move and the dollar could go higher yet.

"Our reading of the statement is that the Reserve Bank is increasingly comfortable that the economy has reached a turning point, negating the need for further rate increases," Bagrie said.

The Bank of New Zealand, which thinks Bollard will go again next month, says the New Zealand Institute of Economic Research's next quarterly survey of business opinion due early next month will be a key pointer.

"If labour constraints remain as tight as recent surveys have indicated, then this will unnerve the bank," Toplis said.

* The dollar opened at 73.40USc yesterday morning and traded as low as 73.18USc before the Reserve Bank announcement at 9am, but spiked immediately afterwards, NZPA reported.

It came off the boil later, but received a further boost from a US dollar sell-off and topped at 74.49USc before closing at 74.30USc, compared with 73.79USc at the same time on Wednesday.

The kiwi also performed strongly against the aussie - buying 93.23Ac at 5pm compared with 92.58Ac at the same time on Wednesday.

Moving the market

* Kiwi dollar hits new high.
* Sharemarket tumbles.
* 90-day bank bill tops 7 per cent.