Bank pauses as global outlook points to gloom

By BRIAN FALLOW economics editor

Acting Reserve Bank Governor Rod Carr left interest rates unchanged yesterday and is "not at all certain" any further rises will be needed.

"My judgment is we can afford to pause, to wait and watch," Carr said.

What has given the bank pause is the "storm warning" from the global economy, especially the risk to the world recovery posed by the steep falls in share prices.

"A weaker world will do some of the work monetary policy would otherwise have had to do," Carr said.

Although the economy's resources are stretched, following three years in which growth has averaged an above-trend 3.5 per cent, and core inflation indicators are all pointing close to 3 per cent, there are recent signs that the economy is losing momentum.

They include some moderation of growth in retail sales, a slowdown in activity in the housing market and lower consumer and business confidence.

"As a result we are not treating the potential need for a further rise in interest rates as urgent, or at all certain," said Carr.

The bank's projections still include some increase in short-term interest rates, to around 6.25 per cent in the first half of next year.

That would imply one or two more 25 basis point increases in the official cash rate, which is 5.75 per cent.

But that is a much more modest increase than was foreshadowed in the previous monetary policy statement in May, which had 90-day bank bills averaging 7 per cent through next year.

Carr yesterday emphasised the highly conditional nature of such projections.

One economist who thinks the bank has done its dash in terms of raising rates is Deutsche Bank chief economist Ulf Schoefisch.

There was sufficient evidence the economy was losing momentum, he said, while the world outlook was more likely to worsen than improve.

Another factor is forthcoming changes to the policy targets agreement (PTA) between Finance Minister Michael Cullen and the new governor, who is expected to be appointed next month.

"The changes to the PTA will most likely instruct the Reserve Bank to be more willing to use the full width of the target range," Schoefisch said.

"The central forecast scenario released today shows inflation retreating to around 1.75 per cent over the course of 2003."

The Reserve Bank says that assessing the likely path of inflation requires assessing the inflationary response to economic growth.

"This is not simply a mechanical exercise of identifying a certain growth rate or speed limit for the economy beyond which inflation will emerge."

The economy's ability to grow without inflation has been boosted by a surge of net immigration (though it expects that to taper off) and by a rise in the participation rate - the proportion of people of working age who are either working or actively seeking work.

But the bank notes that its inflation forecasts over the past year have proven optimistic.

"Although the economy's ability to grow without generating inflation has proven stronger than we thought, so too has its actual growth performance."

And it cites three different measures of core inflation - which filter out one-off or unusual price movements or price changes that monetary policy should not respond to, such as international oil prices or fruit and vegetables. All three are close to 3 per cent.