Bollard alert for danger signs

By BRIAN FALLOW economics editor

Reserve Bank Governor Alan Bollard has taken his foot off the gas pedal and has it poised mid-way between accelerator and brake.

"Wait and watch" is now the watchword after Bollard, as expected, left the official cash rate unchanged at 5 per cent.

The monetary policy statement and Bollard's comments were resolutely neutral. "We are not taking the view that the easing is definitely over or that we are starting to tighten. We are pausing to see what the data deliver up over the next few months," he said.

The bank now forecasts a gentler slowdown than it did three months ago. Growth is expected to slow from the current rate of around 4 per cent to more normal rates of 2.75 per cent for the year to next March 31 and 3 per cent for the year after.

The inflation forecast has been raised, too, to around 2.75 per cent in 2005.

But that is predicated, among other things, on the bank's standard assumption that the dollar will fall back to its long-run average, 57 to 58 on the trade-weighted index, over the medium term. The TWI stood at 61.7 at 5pm yesterday.

Many forecasters, however, expect the dollar will go higher before it falls and the bank may do too, though it would be reluctant to publicly project a higher dollar lest the financial markets see that as sanctioning it.

The bank has not altered its forward track for short-term interest rates from what it was three months ago. It shows rates remaining about where they are now until the middle of next year then gradually rising to around 5.75 per cent by the second half of 2005.

By contrast, futures market prices imply an aggressive tightening starting early next year, with 90-day interest rates reaching 6.25 per cent by the end of the year.

National Bank chief economist John McDermott finds it telling that the Reserve Bank did not expressly address the gap between its view and the market's.

"I suspect they are secretly quite happy because it does their job for them while they avoid the political heat [of raising interest rates]. It is monetary policy by stealth," McDermott said.

It allowed the forward interest rate curve to provide a de facto tightening, especially in one to three-year rates, the area the housing market is most sensitive to.

The bank regards the present housing boom as more than a structural adjustment,the absorption of a new wave of immigrants, which it could safely ignore. It is both more widespread and longer-lasting than that.

It worries about the spillover effects as higher housing costs and higher rents put upward pressure on wages and divert investment capital from other value-generating activities.

But Deutsche Bank chief economist Ulf Schoefisch regards the Reserve Bank's inflation concerns as overstated.

"The housing market has been strong for quite some time but there has been no evidence of a broadening of inflation pressure, thanks to the appreciation of the New Zealand dollar and the pass-through of lower import costs to consumers."

Westpac chief economist Brendan O'Donovan sees few reasons to expect a quick start to the next tightening cycle.

"Only a concerted pick-up in speculative [housing market] activity is likely to trigger a quick return to higher interest rates. The recent sharp rises in fixed-term mortgage rates may soon dent some of the appeal of housing as an investment vehicle providing easy profits."