Shorter odds on rate rise

It is a toss-up whether Reserve Bank Governor Alan Bollard will raise interest rates when he delivers his monetary policy statement on Thursday.

It depends on what scares him more: the possibility of an epidemic of wage-price inflation or a hard landing for the economy next year. The latter could happen if higher interest rates, and the higher exchange rates they are likely to bring, cause the economy's engines to stall.

Market economists on balance think Bollard will leave the official cash rate on hold rather than resume the rate hikes he called to a halt last October. But the odds have shortened dramatically. In Reuters' latest poll on Friday, six of the 14 forecasters surveyed expected him to raise the official cash rate from 6.5 per cent to 6.75 per cent.

The probability of a rate rise is put at 42 per cent, compared with 20 per cent after the last official cash rate review in late January.

Then, none of the forecasters was predicting an increase. Since then, there has been fresh evidence of how tight the labour market is, and the dollar has risen to post-float highs.

Employment grew 1.6 per cent in the December quarter alone, even if most of the increase was in part-time jobs. The unemployment rate fell to 3.6 per cent and would have fallen further but for a significant increase in workforce participation.

Meanwhile, the net inflow of migrants, which a year ago was relieving some of the pressure on the labour market, continues to dwindle.

And the Engineers Union has launched a campaign for a minimum 5 per cent wage increase.

But the Reserve Bank only has to worry about wage increases which flow through to higher consumer prices across a wide front. Increases which are warranted by higher productivity or which are absorbed by employers' profit margins pose no threat to its inflation target.

The days of a cost-plus economy are gone, argues Westpac chief economist Brendan O'Donovan.

What matters is firms' pricing power, the ability to pass on cost increases without losing business and market share. There is plenty of pricing power in the construction sector, he says, but little in forestry.

"Retailing is as competitive as ever and manufacturing is faced with an overvalued exchange rate and the onslaught of Asian competition."

Bank of New Zealand chief economist Tony Alexander says Bollard gambled that raising the official cash rate from 5 per cent to 6.5 per cent last year would be enough to contain inflation over the next two years.

"But we believe the gamble has not paid off - especially as we cannot find a single home-buyer, farmer or businessperson who is the least bit concerned about interest rates."

He concludes that further rate rises are on the cards.

But O'Donovan says interest rate rises last year and the appreciation of the kiwi dollar represent a substantial tightening of the "monetary thumbscrews'. The preponderance of fixed-rate mortgages, and foreign exchange hedging carried by exporters, have provided some anaesthetic, but that will wear off.

And he points to softer turnover figures from the housing market in January as a sign that that sector - a key inflationary hotspot - is cooling down.