Bollard tipped to raise cash rate

Alan Bollard

If borrowers escape without Reserve Bank Governor Alan Bollard raising the official cash rate to 7.5 per cent on Thursday, it will be a very close shave.

Eight out of 14 economic forecasters polled by Reuters expect a rate hike. They are not emphatic about it, though, putting the probability around 60 per cent.

Financial markets see a 50:50 chance of a hike, according to an indicator constructed by Credit Suisse in Singapore, which reflects swaps market pricing.

When he last reviewed the OCR six weeks ago Bollard indicated a low level of tolerance for any further upside surprises from economic data.

Since then some developments should have reassured him.

Petrol prices have fallen sharply and Statistics New Zealand has increased the weight given to petrol in the consumers price index.

This will reduce the forward track for "headline" inflation and with it the prospect of inflation expectations remaining stuck at levels dangerously elevated from the Reserve Bank's point of view.

The dollar has strengthened and on a trade-weighted basis is now 4 per cent higher than the level assumed in the bank's September monetary policy statement.

"So even if the balance of recent data justifies tighter monetary conditions, the currency could easily be seen as having done the bank's dirty work for it, yet again, in spades," said BNZ economist Craig Ebert.

"Sure, some of this will be unwound if Bollard doesn't hike but then if he does, the [exchange rate] will no doubt exacerbate the tightening."

And the national accounts for the June quarter showed the domestic economy shrank 1.7 per cent, its weakest performance for nearly five years. But there has also been plenty to worry a central bank looking for household consumption to grind to a halt. House price inflation remains at double-digit rates even if sales turnover is slowing.

In a replay of the "mortgage wars" two years ago, fixed mortgage rates on offer tumbled, though they have since climbed back above 8 per cent as the markets have become less convinced the next move in the official cash rate will be down. The Reserve Bank has been counting on a dampening effect from a bulge in two-year loans taken out in late 2004 being reset at higher interest rates.

"With the banks clearly prepared to compete hard, the Reserve Bank stands the risk of losing some of the added hit it has been banking on to ratchet up the squeeze on household finances," said Westpac chief economist Brendan O'Donovan.

"If it wants to ensure mortgage rates are held up then strategically it has to move in October. If it doesn't, the market is going to unwind some of the run-up in interest rates. Waiting until December would mean most of the maturity bubble will escape the impact."

The other development that persuaded many Bollard-watchers that he will raise rates on Thursday was a sharp rise in capacity utilisation recorded by the Institute of Economic Research's quarterly survey of business opinion - a key indicator of the degree of slack in the economy.

But some economists are dubious there really is record capacity utilisation in manufacturing, which has only recently begun increasing production after prolonged weakness.

CS First Boston economist Jason Wong said a rebound in consumer and business confidence, driven by a sharp fall in fuel prices, suggested a recovery in activity in the near term.

"Indeed the sharp fall in oil prices removes a lot of the downside risk to the economy," he said. "If the bank doesn't raise the OCR then a very firm statement which hints at a good chance of a move in December is likely, to ensure wholesale rates don't fall too much from current levels.

"Either way you cut it, interest rates aren't likely to fall in a hurry."

Finely balanced

* Thursday's interest rate call by governor Alan Bollard is on a knife edge.

* Most economists believe he will raise rates, even if they don't think he should.

* If he does, blame Mortgage Wars II - The Sequel.

* If he doesn't, thank the resurgent kiwi dollar.