KEY POINTS:
The Reserve Bank is seeking alternatives to yet higher interest rates in its battle against persistent inflationary pressures -- but raising credit costs may be the most effective weapon it has.
It lifted interest rates last week for the 11th time since 2004 to take them to 7.75 per cent -- the highest in the industrialised world -- warning consumer spending was fuelling underlying price pressures.
But the policy tightening has had limited impact in taming domestic inflation, while in the process pushing the New Zealand dollar to its highest level since it was floated in 1985, choking the country's export sector.
Frustrated by the result, the central bank has said it was seeking alternatives to try to cool the residential sector -- singled out as the main enemy in the inflation fight -- without triggering a rise in the currency.
But analysts say such a weapon does not exist.
"There is no magic bullet," said Craig Ebert, senior economist at Bank of New Zealand.
Supported by a series of factors, including the country's tax policies, demographics and lending practices, the median home price has nearly doubled between 2001 and 2006, making consumers feel wealthier and confident about spending.
The headline annual inflation rate eased to 2.5 per cent in the first quarter, largely due to lower oil prices. But a key measure of inflation generated domestically rose at its fastest pace in three-and-a-half years to 4.1 per cent.
Setting mortgage levies or tightening the implementation of tax laws to capture capital gains might help cool house price inflation, but could prompt a political backlash given New Zealanders' love-affair with the housing market.
Last year, the RBNZ, in a joint study with Treasury, conceded most alternative or supplementary tools to curb inflation were few, fraught with difficulty and would likely be no more effective than the current official cash rate.
The central bank has said it would consider imposing stricter regulations on lenders, such as by raising the capital adequacy ratio. But analysts say such a move would do little to curb lending since home loans are regarded as safe investments.
Growth in government spending, while modest compared with previous years, is another inflationary concern for the central bank.
The government announced last year $12 billion in new spending in the coming four years, focused on infrastructure, education and welfare programmes.
Finance Minister Michael Cullen, under pressure from weakening public support, is expected to announce tax cuts for business in the budget due later in the month.
But he has ruled out personal tax relief, saying it would fuel inflation.
The latest Reuters poll showed only two of 16 forecasters expected a further rise in rates.
But analysts said risks were still skewed to the upside. Indeed, it wouldn't be the first time in the rate-rising cycle that they had thought the central bank was done raising rates.
Inflation signals in coming months would be key, they said.
"If they are not getting any joy by July, that three months is a decent period expecting to see something, and if they are not seeing anything, they'll have no choice but to press on," said Darren Gibbs, chief economist at Deutsche Bank.
Unlike in previous statements, the central bank last week did not suggest further policy tightening may be necessary.
But that doesn't rule out another rate rise, analysts said. They linked the omission to concerns over the soaring New Zealand dollar and its potential to hamper exports and boost imports. The country's current account deficit is already bulging at 9 per cent of GDP.
The currency effect is also eating deeper into the economy.
Whiteware maker Fisher & Paykel Appliances, one of the country's biggest exporters, said last week it would shift part of its manufacturing unit to Thailand in the face of a stronger currency and high interest rates.
Central bank Governor Alan Bollard, in last week's policy statement, said the currency was exceptionally and unjustifiably high, prompting market speculation about the possibility of currency intervention.
But most analysts think such a move, which would be the first since the currency was floated 22 years ago, is highly unlikely.
"Unfortunately for the RBNZ, it's not a kiwi specific thing so much as a broad-based US dollar weakness," said Sue Trinh, senior currency strategist at RBC Capital Markets.
- REUTERS
