Bollard's unheard rate warning

Alan Bollard

The money markets and most economists believe the risk of another interest rate rise this cycle has passed after Reserve Bank Governor Alan Bollard left the official cash rate unchanged at 7.25 per cent yesterday.

But that is not what he said.

His statement was hawkish, if less so than expected: "Further monetary policy tightening cannot be ruled out, and any easing of policy remains a considerable way off."

Medium-term inflation pressures were still significant, he said, although they were abating gradually.

The housing market remained resilient, supported by immigration and banks accepting low-interest margins on mortgages as they chased borrowers.

And the drop in petrol prices, while reducing inflation in the short term, could also lead to an increase in consumer spending.

But the market's reaction to Bollard's statement was dramatic.

The kiwi dollar dropped more than half a cent against the US dollar and wholesale interest rates fell as the market largely removed the increase in interest rates it had priced in.

And a Reuters poll found no economist willing to give more than a 40 per cent chance of another rate rise.

"The market was already half-way there in pricing in another rate hike. All the bank had to do was push the button," said First NZ capital economist Jason Wong.

"It didn't. To us, this sends a strong signal about the bank's desire, or lack thereof, to tighten monetary policy further. Unless we get an out-of-left-field shock, the bank is likely to continue to sit on the sidelines."

Westpac chief economist Brendan O'Donovan said the Reserve Bank had all but led the market to expect a rate rise, then had not delivered one.

Senior Reserve Bank officials had been talking up the risks of higher interest rates to domestic and foreign investors and banks, giving the impression an increase was likely.

By leaving the cash rate on hold, Bollard has lost the opportunity to keep interest rates up for the $15 billion or so of fixed-rate mortgages maturing over the next couple of months and thereby reduce household spending as he wants to do.

Two-year swap rates fell in response to less-hawkish-than-expected statements by the American and New Zealand central banks.

"Bank margins are very thin," O'Donovan said.

"There is extreme competition, and I think the drops in the wholesalemarket will be passed through to borrowers."

Yesterday's market reaction could increase the Reserve Bank's concerns about medium-term inflation and bring about a rate rise, O'Donovan said.

But it would be much harder to make a case for a rise in December when the mortgage pipeline opportunity had been lost and the inflation figures were likely to be zero for the quarter and 2.8 per cent for the year.

Where Westpac thought Bollard did not need to increase the rate but probably would, the Bank of New Zealand thought he needed to but probably would not.

"The idea that because he didn't go today he never will is a mistake," said BNZ economist Craig Ebert.

"If we have another strong employment result and the unemployment rate went further down and wage growth popped back up again, that could well trigger a rise.

"It's still wide open as far as we're concerned."

Rush to judgment

* The markets were half-expecting Alan Bollard to lift interest rates.

* He didn't, and they decided he is not now likely to do so.

* But that conclusion may be a bit premature.