Bollard bides his time on interest rates

By BRIAN FALLOW economics editor

The Reserve Bank is having second thoughts about the need to raise interest rates.

Governor Alan Bollard, who surprised the markets when he raised the official cash rate from 5 to 5.25 per cent in January, left rates on hold yesterday, saying he would "wait and watch the data to see whether a further small increase in interest rates will be required this year".

The bank has cut its forecast for economic growth in the short term compared with the December monetary policy statement.

It now expects growth of 1.75 per cent over the year to March 2006, down from 2.5 per cent in the December forecasts.

The latest forecasts reflect the assumption that there will be one more 25 basis point rise in interest rates.

The bank has also halved its estimate of the population gain from net migration to an annual tally of around 10,000 by the end of this year.

Together with the lagged effects of the high New Zealand dollar that should deliver the slowdown in economic activity needed to ease inflationary bottlenecks.

"However, the latest activity indicators remain quite robust. This implies that in the short term there are ongoing risks that the bottlenecks in the economy persist for some time yet." Hence the wait-and-see stance.

The bank is worried by the extent to which household spending is outstripping growth in incomes. The savings rate, it estimates, is a negative 10 per cent reflecting the "wealth effect" as high house-price inflation boosts homeowners' wealth and they borrow and spend on the strength of that.

Given signs that the housing market is cooling, that raises the possibility of a sharper correction in domestic demand than the bank had previously reckoned on. Westpac chief economist Brendan O'Donovan said it was encouraging that the Reserve Bank was putting more emphasis on the risk to the growth outlook next year rather than the here-and-now.

"But I wouldn't discount the probability of another rate hike if the dollar stays down."

Bank of New Zealand economist Stephen Toplis said: "It got spooked by the possibility of generating a hard landing by raising rates. The indicators are saying things could get ugly, but we are not seeing it yet."

Bollard rejected the idea that he had been too quick to raise rates in January.

But Deutsche Bank chief economist Ulf Schoefisch said that starting a tightening or easing cycle should require a level of conviction consistent with at least two interest rate moves. Neither the fact that since January the dollar had temporarily hit new cyclical highs nor data confirming the slowdown of the economy should have come as a surprise to the Reserve Bank.

It raised concerns about consistency, he said.