Economy expected to grow faster

Reserve Bank Governor Graeme Wheeler. Photo / Mark Mitchell

Reserve Bank keeping watch on construction and house price inflation.

The Reserve Bank's latest forecasts paint a picture of improving growth, subdued inflation, low interest rates and falling unemployment next year.

The flies in the ointment, though, are a dollar which remains stubbornly high, worsening external accounts, and the risk that the housing market and construction costs will not prove as well behaved as the bank expects.

The December monetary policy statement has growth accelerating from an annual rate of around 1 to 1.5 per cent now to the 2.5 to 3 per cent range by 2014 and 2015.

The $30 billion task of rebuilding Christchurch is the biggest impetus behind that, even though the bank's forecasts have the peak in that spending not occurring until 2015 and 2016.

It sees further support from falling mortgage rates, reflecting lower bank funding costs.

And it sees the international outlook as still soft but less threatening than three months ago, with the data out of China improving and an expectation that the United States will muddle through its fiscal problems.

On the negative side of the scales are the effects of the high dollar, especially on firms competing with imports, continued caution on the part of households and the contractionary effects of fiscal policy.

The statement devotes much more space to discussing the risks that inflation will prove stronger than its central forecast, than to the possibility that inflation might continue to come in weaker than it expected.

Construction costs in Canterbury have soared while they continue to rise only moderately in Auckland and nationwide.

Evidence of a spillover of construction cost inflation to the rest of the country is one risk it is on the watch for.

Another is that house price inflation will take off.

It is already running at double-digit rates in Auckland, but the bank expects it to get no higher than 5 per cent nationwide, arguing that houses are already expensive relative to incomes and rents, that residential construction is picking up, and that household behaviour has changed since the boom years.

Households are using mortgage rates at 50-year lows to repay debt faster, rather than seeing rising equity in their home as a licence to go out and spend more than their income.

Should that change, all else being equal, the bank will raise the official cash rate sooner than it currently expects to, which is early 2014.

Discussions with the Government about when and how macro-prudential tools, including the regulation of loan-to-value ratios, might be used are well advanced. Wheeler reiterated that those tools were intended to combat asset bubbles that might threaten financial stability and do a lot of damage when they burst.