Bollard tipped to lift rates to cool economy

Alan Bollard

Reserve Bank Governor Alan Bollard is all but certain to raise interest rates again on Thursday and leave the door open to yet another rise.

Fourteen out of 15 banks and brokerages surveyed by Reuters expect him to lift the official cash rate 25 basis points to 7.25 per cent when he releases the bank's December monetary policy statement - with a one-in-five chance of a 50 basis points rise.

"One could not rule out a 0.5 per cent move," said Bank of New Zealand chief economist Tony Alexander, "but the Reserve Bank would have to weigh the kick in the head of the consumer factor - good for fighting inflation - against the risk of putting the economy into recession next year."

When Bollard last raised the OCR on October 27 he said: "The most serious risk to medium-term inflation is the continuing strength of household spending, supported by a relentless housing market and rapid growth in mortgage lending."

He warned that further tightening might be ruled out only once "a noticeable moderation in housing and consumer spending" was observed.

The flow of data since then has failed to provide him with much comfort on that score.

The Real Estate Institute reported some softening of activity in the housing market in October with sales down a seasonally adjusted 8.7 per cent from September, but the national median sale price hit a record $295,000, up 17 per cent on a year earlier, and houses continue to sell fast by historical standards.

Mortgage debt continues to grow about twice as fast as household incomes. It expanded $1.4 billion to $117.4 billion in October to be 16 per cent higher than a year ago.

Retail sales in the September quarter, excluding the automotive sector, grew 0.9 per cent in real terms, only half the blistering pace of the June and March quarters.

But more timely data such as credit card billings remain strong and the wharves continue to groan under the weight of imports, the trade balance blowing out to $6.1 billion, implying strong domestic demand.

Meanwhile the labour market remains tight and labour costs are climbing.

The number of people employed grew 1.3 per cent in the September quarter, making 3.5 per cent for the year, and the unemployment rate fell to 3.4 per cent, the lowest in the developed world and the lowest in New Zealand for 20 years.

The bank's preferred measure of underlying wage inflation, Statistics New Zealand's private sector labour cost index, rose 0.8 per cent in the quarter, pushing the annual increase to 2.8 per cent from 2.5 per cent in June and March.

These figures are intended to be an indicator of unit labour costs; the pay increases employees actually get are adjusted to deduct that part which can be seen as compensation for higher productivity.

The unadjusted labour cost index, which reflects what is happening to pay packets and payrolls, jumped 2.1 per cent in the September quarter, making 5.5 per cent for the year.

Firms face cost pressure on other fronts as well.

Producer prices are rising far more sharply on the input side (up 2.9 per cent in the September quarter) than the output side (up 1.8 per cent). For five of the last six quarters the producers price index has recorded a squeeze on firms' profit margins.

ANZ National Bank chief economist John McDermott said that while the compression of margins was an encouraging sign from the Reserve Bank's point of view, that competition is limiting firms' ability to pass on cost increases, and lower profitability potentially undermined their willingness to hire and invest, "the very sources of growth needed to keep this business cycle expanding".