Bollard stays downbeat as he puts rates up

Reserve Bank Governor Alan Bollard says global prospects have deteriorated. Photo / Mark Mitchell

For a central bank governor pushing up the benchmark interest rate, Alan Bollard was distinctly downbeat and dovish yesterday.

The world economy's recovery was fragile and its prospects had deteriorated, he said, while the dollar was higher than a softening economic outlook and lower commodity prices would justify.

At home, demand was subdued, households cautious, housing market turnover in decline, credit growth weak, business investment very low - and a slowdown in net immigration would further dampen consumer spending, he said.

Despite all that, the Reserve Bank continues to predict "respectable" economic growth in the near term and believes it appropriate to continue to wind back the extraordinary level of monetary stimulus - 5.75 percentage points of OCR cuts - it dispensed during the recession.

As expected, Bollard raised the OCR from 2.75 to 3 per cent. That still leaves the OCR at a very supportive level, he says.

But he acknowledged what has has been apparent to the financial markets for a while: the outlook for growth and inflation no longer warrants the staircase of rate rises at almost every opportunity over the year ahead, which he had foreshadowed, saying: "The pace and extent of further OCR increases is likely to be more moderate than was projected in June."

Then, the projected track for short-term interest rates implied they would rise 1.7 percentage points to 5 per cent over the year ahead, implying 25-basis-point hikes at seven of the eight reviews. The market thought five was more like it. With July's now delivered, the market is "pricing in" 90 basis points (0.9 percentage points) of rate rises over the next 12 months.

Bollard pointed in particular to high levels of confidence among manufacturers and to expanding forestry exports. But ANZ's head of market economics, Khoon Goh, said that while confidence in the manufacturing sector was undoubtedly high, he questioned whether growth would be strong enough to offset weak domestic demand. Trade data released yesterday showed that while forestry exports in the June quarter rose 12 per cent in value, they fell nearly 4 per cent in volume.

Imports of capital plant and machinery fell last quarter, as they have in six of the past eight quarters.

Bank of New Zealand head of research Stephen Toplis said the weakness in investment and the drop-off in net migration both reduced the economy's capacity to grow.

The net population gain last month was just 70 people. This does not just dampen consumer spending, as the Reserve Bank said, "it also adversely affects the supply of labour at a time when anecdotal evidence again suggests mounting skill shortages.

"The drop in demand is disinflationary but the drop in supply of labour is inflationary," Toplis said.

ASB chief economist Nick Tuffley expects Government policy changes, especially the GST increase, to push annual headline inflation well over 5 per cent by the middle of next year.

Bollard yesterday repeated his key assumption that this would not spill over into persistent and general inflation. But he will be watching the situation closely.

Tuffley said the Reserve Bank's own survey of inflation expectations two years ahead - by which time the policy-driven spike in inflation should have passed - had continued to edge up and was now sitting close to the 3 per cent top of the bank's inflation target.

The pundits' view ...

After the Reserve Bank's dovish statement yesterday, here is how market economists see the near-term outlook for the official cash rate:ANZ: A 60 per cent chance of another increase in September, then a pause. ASB: Still thinks the OCR will rise steadily to 5 per cent. But if the Reserve Bank does pause, it will be in December after two more hikes to 3.5 per cent.

* BNZ: Another hike in September and at least one more before the end of the year. But it now thinks the peak will be 5.5 not 6 per cent.

* Deutsche Bank: A September hike is more likely than not followed by a pause for three months.

* Goldman Sachs JBWere: Two more hikes this year, though it is increasingly sympathetic to a pause in September.

* Westpac: The bank will continue to work its way towards a peak in the OCR of 6 per cent by early 2012, consistent with a 25-basis-point hike at every review. There could well be some pauses along the way but, equally, there could be some larger hikes.