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Home / Business / Economy / Official Cash Rate

<i>Fran O'Sullivan:</i> How far will Bollard go?

Fran O'Sullivan
By Fran O'Sullivan,
Head of Business·
9 Jun, 2007 05:00 PM4 mins to read

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KEY POINTS:

National leader John Key's warning that the NZ dollar may bust the US80c mark - after the Reserve Bank again hiked interest rates - should be taken seriously.

The former London-based head of global foreign exchange for investment bank Merrill Lynch was immediately pasted as a money market
speculator by Finance Minister Michael Cullen, who is endeavouring to create a wedge between Key and his finance spokesman Bill English ahead of next year's election.

For an experienced pol such as Cullen that should not normally be too difficult an ask.

But politicians from both sides need to be reminded that the escalating currency and interest rates are hugely worrying for many New Zealand businesses, which are already struggling to come to terms with other hot issues such as the skills shortage.

This is not the time for either side to play wedge politics or indulge in political one-upmanship.

Or politically sanction an economic hard landing orchestrated by the Reserve Bank, which will have huge collateral damage.

What small businesses (many of which have secured their company loans against their houses) want to know is how far Alan Bollard is prepared to up the interest rate ante to bring about his stated desire to curb the housing market, and deal with an expected inflationary surge caused by bumper dairy payouts.

He raised the official cash rate to 8 per cent and most economists predict it will be raised again in July. Others, sotto voce, are concerned that NZ may be headed back to the type of interest spirals we have not seen since 1990/1991 when mortgage rates hovered around the 15 per cent mark, and the sustained period in the mid-1990s when rates were around 10-11 per cent.

Westpac chief economist Brendan O'Donovan, who correctly predicted this week's rise, warns there is a risk the current dairy boom will give NZ a case of the Dutch disease when a bonanza from the discovery of natural gas in the North Sea drove the exchange rate up to levels that crippled other export sectors.

Another economist warns Bollard will basically bash things until the labour market turns.

Stripped of the niceties, this means Bollard is intent on causing the type of train wreck that will either burst the housing market bubble (the central bank notes housing prices fell by nearly 40 per cent over six years in the 1970s), bring the Government to its senses over its own spending, dampen wage demands and force people out of work. Ideally, all three.

Trouble is, by signalling his intentions so publicly, offshore investors have again been given an open invitation to invest in NZ bonds safe in the knowledge Bollard will not pull the pin for another two years.

This leaves NZ businesses caught in a vicious cycle.

With exchange rates at their current levels and predicted to stay so for some time, the smart money will be tempted to cash out and shift funds offshore.

This is what happened the last time the exchange rate spiked significantly during the 1990s.

Others, such as Pumpkin Patch, are battening down the hatches as earnings are flattened by the high dollar and interest rates.

If this practice becomes writ large among exporting companies, profits will slow and with them the corporate tax take.

It may well be that Bollard has Cullen's tacit approval to raise the interest stakes because it will help to create the political conditions that would enable the Finance Minister to introduce a capital gains tax or other measures to curb housing investment.

But the net result is likely to be catastrophic for exporters.

Far better that Cullen, Key, et al, bury their political differences and start seeking a bipartisan solution now, rather than waiting for the economy to stall.

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