Bollard to stay resolute on rates

Reserve Bank Governor Alan Bollard will almost certainly keep the official cash rate on hold at 7.25 per cent when he reviews it this Thursday. Economists expect him to reinforce his determination to "hold the line" against risks that high inflation will become entrenched in wage and price-setting behaviour.

Money markets are now pricing in an outside chance of a further rate rise and no easing until the second half of next year.

But economists are taking a less pessimistic view. All 14 economic forecasters polled by Reuters expect no change in the OCR this week, or for the rest of the year for that matter, but nine of them believe Bollard will start cutting rates in March next year.

In a speech this month he said that with world interest rates now on the rise domestic monetary policy was becoming more effective. A lot of fixed-rate mortgages come up for renewal over the rest of this year and those rates are on the rise too.

But the nine monetary "tranquilliser darts" Bollard shot into the hide of the housing market through 2004 and 2005 have yet to bring it to its knees.

The Real Estate Institute reported turnover last month was up 5 per cent on June last year and prices on average were up 8.8 per cent.

A more comprehensive measure of house price inflation, from Quotable Value, shows the annual rate declined to 12.3 per cent in the year ended March, down from 15.3 per cent three months earlier and a peak of 24.8 per cent in calendar 2003.

"Things have eased off but the market still remains relatively robust," said Bank of New Zealand chief economist Tony Alexander.

Growth and inflation data have come in stronger than the Reserve Bank forecast in its June monetary policy statement, but by only a tenth of a percentage point in both cases.

But the June inflation figures provided little comfort, with the consumer price index up 1.5 per cent for the quarter and 4 per cent for the year.

Even excluding petrol prices, inflation was 2.9 per cent.

The trimmed mean measures (which lop off the largest rises and falls in order to capture what is happening to the broad mass of prices in between) recorded 3.2 per cent inflation.

The non-tradeables sector, the parts of the economy most susceptible to domestic interest rates, recorded inflation of 1 per cent for the quarter and 4.1 per cent for the year.

ANZ National Bank economists warn that persistently high oil prices and further declines in the exchange rate will impart a degree of stickiness to the headline inflation rate.

If oil prices stabilise around US$70 a barrel, a decline in the New Zealand dollar to US50c to 55c would send petrol prices to $1.90 or $2 a litre, they warn, enough to add 0.9 percentage points to inflation over the next 12 months.

But it would also suck spending power out of an already enfeebled economy and ultimately the negative effects on growth would counter that direct impact on prices.

Alexander said: "Our view is that the inflation rate is not going back below 3 per cent until 2008."

Westpac chief economist Brendan O'Donovan said the Reserve Bank's concern with the spike in inflation was the potential flow-on impact to price- and wage-setting. But he said monetary conditions had tightened since the June statement. The two-year swap rate, a key wholesale interest rate from which fixed-rate mortgages are priced, has risen 15 basis points. Some of the banks have raised their fixed interest rates accordingly.

ASB bank economist Daniel Wills said many fixed-rate mortgages would come up for renewal over the rest of this year. Indications were that borrowers would be facing mortgage rates over 8 per cent, compared with rates below 7 per cent in early 2004.