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Home / Business / Economy / Official Cash Rate

Interest rates to stay put, gurus predict

Brian Fallow
By Brian Fallow
Columnist·
25 Apr, 2005 11:59 AM3 mins to read

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Market economists are unanimous in expecting the Reserve Bank to leave interest rates on hold when it reviews them on Thursday.

But the tone of the bank's statement is expected to be stern and to imply that the next move in interest rates is more likely to be up than
down.

The financial markets are pricing in some chance of a fall in interest rates by the end of the year.

Economists are less sanguine, however. All of the forecasters surveyed by Reuters last week expect the official cash rate to be unchanged at 6.75 per cent at the end of the year, apart from the Bank of New Zealand, which expects it to be higher.

One reason is that inflation is already close to the top of the bank's 1 to 3 per cent target range, leaving it with little tolerance for upside surprises.

Although the consumers' price index rose a less-than-expected 0.4 per cent in the March quarter, making 2.8 per cent for the year, it was a steep drop in international air fares that kept it respectable.

Core inflation - excluding the biggest 10 per cent of price rises and falls - is already at 3 per cent.

And the Institute of Economic Research's latest survey of business opinion recorded intense inflation pressures, with little spare capacity in the use of physical plant and acute labour shortages.

However, HSBC chief economist John Edwards said that while the Reserve Bank's forecast of inflation motivated its rapid tightening last year, it would be doubling up to claim it as a good reason to tighten again now.

The biggest inflationary hotspot has been the housing sector.

The news from that front has been mixed lately, with the fundamentals continuing to point to a slowdown but prices suggesting ongoing strength in the market.

The population gain from net migration peaked two years ago and has dwindled to almost zero. But on the supply side, building consents have held steady for the past four months, seasonally adjusted.

Rents rose a scant 2.2 per cent in the year ended March, yet house prices (on Real Estate Institute figures) were 16.2 per cent higher over the same period.

Those factors are being mitigated, however, by the influence of interest rates. Since the Reserve Bank raised the official cash rate on March 10 floating mortgage rates have risen but fixed lending rates have fallen.

More than 80 per cent of all mortgage debt is at fixed rates and therefore unaffected by cash rate increases until the loan's fixed term expires and the rate comes up for reset. Even then, prevailing world bond yields affect the fixed mortgage rates on offer as much as short-term New Zealand rates do.

The bank estimates that only about half of the seven interest rate rises (1.75 percentage points in all) have flowed through yet to the effective interest rates mortgage borrowers are paying.

Consequently the cash rate rises have done little to dampen consumer spending .

Retail sales remain brisk, climbing an impressive 3 per cent in the first two months of the year, albeit from a subdued December.

The Westpac quarterly survey of consumer confidence, while softer, remains at historically high levels.

Meanwhile the dollar, which has kept the lid on inflation in the face of strong domestic inflation pressure, remains high.

It is off the 20-year peak it hit after the bank's March rate rise but it has been creeping higher again.

At 71.3 on the trade-weighted index yesterday it was above the average level assumed by the bank for the first half of 2005.

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