It may be six months or so before the Reserve Bank begins to raise the official cash rate, but monetary tightening is already under way.

The exchange rate is a major component of monetary conditions in a small and open economy like ours.

Only last week the New Zealand dollar was sitting at record highs on a trade-weighted basis and even though it has eased a bit since then it is still 8.5 per cent above its levels in the middle of last year.

Longer-term interest rates have also climbed.


Ten-year Government bonds which are trading at yields around 4.5 per cent were at 3.3 per cent as recently as last May - until US Federal Reserve chairman Ben Bernanke raised the prospect that the Fed might be approaching the point where it could begin to scale back its quantitative easing from the US$1 trillion-a-year pace it has been running at.

It now looks as though that "tapering" might be pushed back to March next year or even later, his New Zealand counterpart Graeme Wheeler reckons, but in the meantime most of the resultant rise in global longer-term interest rates has stuck.

Accordingly the fixed mortgage rates on offer for three-, four- and five-year terms have all risen by about 40 basis points since May.

To the extent that this tips borrowers towards floating and short-term fixed mortgages it increases the traction Wheeler will get when he does raise the OCR.

And now the banks have begun to tighten the availability of credit, to some would-be borrowers at least, prodded by the regulator's concerns about high loan-to-value ratio (LVR) lending.

"We have found special offers have disappeared and low equity premiums have been introduced, and we have seen a rationing of credit in respect of pre-approvals," Wheeler said last week.

The number of housing loan pre-approvals over the past three months is down 3 per cent on the same period last year, and the value up 4 per cent. A year ago they were running 20 per cent ahead of a year earlier by number and 33 per cent higher by value.

During the 2008/09 recession the Reserve Bank cut the OCR from 8.25 per cent to 2.5 per cent, a massive easing in anyone's book. Apart from a brief flirtation with higher rates in the second half of 2010, the OCR has remained at that all-time low for 4 years, delivering mortgage rates at multi-decade lows. But such support can only be temporary.


Leave a plaster cast on for too long after the bone has healed and it starts to do more harm than good.

In particular a prolonged period of cheap money can inflate asset bubbles, the bursting of which has gruesome consequences, as a number Northern Hemisphere countries in recent years can attest.

Right now the economy is expanding at an annualised rate north of 3 per cent.

Having to rebuild our second largest city after a natural disaster is not how anyone would design a stimulus package, but stimulus it is and on a scale HSBC's chief economist in this part of the world, Paul Bloxham, says is comparable to that Australia derived from its mining investment boom.

Meanwhile, high export prices have pushed the terms of trade back to within 2.5 per cent of their 37-year high two years ago, boosting national income.

The third leg of the growth stool is a buoyant housing market. House prices nationally have risen just under 10 per cent over the year to September, to a record high, and by 17.5 per cent in Auckland.

This is tough on people trying to get on to the housing ladder, but for those who already are the chances are that when they get their annual letter from Quotable Value saying they are tens of thousands of dollars richer than they were a year ago, they will go out and spend a few cents in the dollar of that additional equity, turbocharging consumption in the process.

The problem is that all that is demand-side stuff. The supply side of the economy presents a less cheerful picture.

Growth rates in the 3 to 4 per cent range are fine while there is spare productive capacity to be taken up but beyond that point the sustainable growth rate, based on fundamental factors like growth in the labour force and in labour productivity, has to be respected. And that is probably in the 2 to 2.5 per cent range.

The turnaround in net migration will boost the workforce, but lifting the productivity growth rate is more of a challenge.

Private investment as a share of GDP plunged during the recession, hitting a 17-year low in 2010, and since then has barely recovered to its average since the early 1990s, says BNZ economist Craig Ebert.

But Ebert points hopefully to investment intentions in business confidence surveys as consistent with solid growth in capital expenditure. A pick-up in imports of plant and machinery indicates firms may now be following through on those intentions.

ANZ's chief economist Cameron Bagrie says New Zealand's productivity story is improving rapidly.

One economist who thinks the Reserve Bank should now be raising the OCR is BNZ's head of research Stephen Toplis.

"All the indications are that interest rates should be quickly returning to neutral ... , " he says.

The Reserve Bank has lowered its estimate of where the neutral short-term interest rate lies - one which is neither stimulatory nor contractionary - to around 4.5 per cent from 6 per cent before the global financial crisis. While that means it will have to raise rates less in the course of "normalising" them, it is still 2 percentage points higher than the OCR is now.

Another economist who thinks it should just get on with it is NZ Institute of Economic Research principal economist Shamubeel Eaqub.

"An overheated housing market means the Reserve Bank needs to act," he says.

It is currently using macro-prudential tools, specifically curbs on high LVR lending, but Eaqub argues this is inviting political interference in the central bank's independence.

There has been a lot of vicarious hand-wringing on behalf of first home buyers, first from the Government and latterly from the Opposition.

Eaqub says: "It would be better to raise interest rates and manage the economic risks, or adjust bank capital requirements."