Bank picks rate drop next year

By BRIAN FALLOW

The Reserve Bank is unlikely to feel the need to adjust interest rates before the September quarter next year, and then the move will be down, says Deutsche Bank in its latest quarterly economic forecasts.

It expects economic growth to continue to slow from an annualised pace of around 3 per cent now - down from 5 per cent in the first half of the year - to about 2 per cent by the end of next year, before turning up again.

"Many of the key factors that have supported the economy over the past year - a low dollar, strong terms of trade, strong net inward migration and low interest rates - will become less supportive going forward," said chief economist Ulf Schoefisch.

A modest slowdown to 2 per cent would relieve some of the excess demand pressures in the economy, evident in the tight labour market and high level of capacity utilisation.

"That's why we think the Reserve Bank will let it run for a while before they see the need to ease interest rates," Schoefisch said.

"The tightening didn't go very far this time. At [an official cash rate of] 5.75 per cent we are probably around about neutral so we never really got into a monetary policy squeeze this cycle."

Deutsche Bank expects the exchange rate to continue to rise, to 53USc over the next year, mainly reflecting a weakness in the United States dollar.

But against the Aussie the rate is expected to remain at its current elevated level, in the absence of any significant narrowing of interest rate differentials between New Zealand and Australia.

However, a widening balance of payments deficit will limit how far the currency can rise.

Although there are signs that spot prices for key commodities like dairy products may have bottomed out, the steep decline over the past year or so has yet to show through in a much reduced trade surplus, and lower rural incomes.

This week's retail sales data showed a two-speed economy, Schoefisch said, with the rural regions slowing while Auckland enjoyed the delayed benefits of the fading rural boom, and the stimulus of immigration and the America's Cup.

"It's the mirror image of what we had a year or two ago when the regions were bubbling along quite nicely, but people in Auckland were not seeing much of a benefit."

Auckland's housing market was benefiting not only from immigration but from a shift in expectations on interest rates.

Schoefisch said the main risk was that the global recovery would be slower than expected and that the prospects of war in Iraq had introduced several incalculable factors.