Bollard tipped to lift rates this year, as inflation stirs

The Official Cash Rate is expected to be left at a record low 2.5 per cent next week, but most economists expect it to be lifted in December. Pictured: Reserve Bank Governor Alan Bollard. Photo / Mark Mitchell

Reserve Bank Governor Alan Bollard is expected to keep the official cash rate unchanged next week while signalling the stimulus of a record-low OCR will be removed sooner rather than later as inflation pressures start to stir.

Bollard will keep the OCR at 2.5 per cent when he releases the Monetary Policy Statement on September 15, according to a Reuters survey of 12 economists. By year-end the OCR is seen at 3 per cent.

Economists have wound back their expectations for Bollard's urge to hike soon, even though he said in late July there was "little need" for the emergency 50 basis point rate cut in March to stay in place much longer. Since then the global outlook has worsened, thanks to Europe's sovereign debt crisis and America's near-default and credit rating downgrade.

"The near-term global outlook has taken a nasty turn, as fears of sovereign debt default have spilled over into a broader range of markets," Westpac chief economist Dominick Stephens said in his MPS preview yesterday. "Our view is that the RBNZ will hold off on rate hikes until December."

By then, Bollard will be talking to the next administration's finance minister.

New Zealand government bond yields are at their lowest in more than two years, following the rally in US Treasuries. Prices of NZ bonds have surged this year even as the Debt Management Office sold a record $20 billion of notes in the year ended June 30.

Typically bonds prosper in times of economic downturn, which makes their fixed payments more attractive. But in the current environment, New Zealand's growth is robust relative to the rest of the world, even in the face of figures this week that showed the volume of building work put in place fell to a decade-low in the second quarter.

Next week's report will be Bollard's first opportunity to update his forecasts in detail since the June MPS, which had first-quarter gross domestic product of 0.3 per cent and the consumer price index rising 0.7 per cent in the second quarter. In the event, GDP grew 0.8 per cent and the CPI in the quarter rose 1 per cent.

The high New Zealand dollar is restraining imported inflation and creating headwinds for a primary sector enjoying relatively high global commodity prices. Domestically, a building boom in Christchurch may drive up prices of services and materials.

The trade-weighted index is well above the RBNZ's assumed track in the June statement of around 68.5 and was recently at 72. The 90-day bank bill is also higher, at around 2.96 per cent, compared to the June estimate of 2.6 per cent.

Bollard may lift the projected track for inflation in next week's statement.

Inflation expectations "remain stubbornly high," funds manager Harbour Asset Management said in a report this week. "We think the market is under-estimating the need for them to get on with things once the threat to the international financial system subsides."