Market prices in October rate hike

Homeowners could feel the pinch of a mortgage rate hike as early as next month, economists say, as the Reserve Bank (RB) looks to halt to New Zealanders' insatiable appetite for spending.

Yesterday's horror trade data, which showed the country's trade deficit swelled to $1.1 billion in August -- the highest of any month on record -- has left the central bank with no choice but to go for the "tough love" option on interest rates.

"The word on the street is that the RB is losing patience," ANZ National Bank's head of market economics Cameron Bagrie told NZPA.

"They've been waiting for a slowdown in the domestic economy. They've barked very loudly over the past six months. They've signalled they could raise rates. They haven't. But the inside word is their patience is running out."

On the money market, 90-day bank bill rates -- the wholesale rate from which banks fund some mortgages -- have risen from 7.05 to 7.17 per cent in the past two weeks.

"The market is pricing in a fair chance of a rate hike in October. It's about a 60 per cent probability at the moment," Mr Bagrie said.

That rises to 80 per cent in regard to a rate hike by year end.

"After months of treading water, RB pricing has spent the last two weeks creeping higher," Westpac currency strategist Johnathan Bayley said.

Mr Bagrie says New Zealanders' Freddie Mercury-style spending patterns -- "I want it all and I want it now" -- have led to the severe trade imbalance, where spending on foreign goods far outstrips earnings from exports.

The country has a household dissavings rate of 10 per cent, meaning that for every dollar New Zealanders earn, they spend $1.10.

"That is unsustainable long term," Mr Bagrie said.

The RB is in a bind when it comes to rates. Growth, in real terms, rather than borrowing and spending is slowing. But inflation is on the rise, driven largely by high oil prices.

If the RB hikes the official cash rate that should slow spending and inflation, but may stimulate further yield-related demand for the Kiwi dollar, which will hinder export-led growth.

The New Zealand dollar has profited in the past year from the country's 6.75 per cent cash rate -- the highest in the industrialised world.

But reaction to last week's $12 billion current account deficit and this week's trade deficit suggests the tide may be turning.

On a trade-weighted basis, against a basket of major currencies, the kiwi has fallen 2.5 per cent since September 15.

"The implication is that the market is increasingly reluctant to sponsor the New Zealand dollar on higher yields when they come against a backdrop of slowing growth and higher inflation," Mr Bayley said.

While a rate hike would provide a temporary fillip to the kiwi, economists expect the unit to fall sharply in 2006.

"The surest thing is that when the New Zealand dollar goes, it will fall an absolute country mile and very quickly," Mr Bagrie said.

"My guess would be 5-10c in the space of six months."

To restore balance to growth and really kick exports into gear, he expects the kiwi to trade below US60c.

"We need the currency to have a five in front of it."

The New Zealand dollar was hovering around a two-month low of US68c this afternoon.

The next RB rate meeting is on October 27.

- NZPA