Bollard likely to hold off on rates

By BRIAN FALLOW

Economists and money market participants are all but unanimous that Reserve Bank Governor Alan Bollard will leave interest rates on hold on Thursday.

But in a u-turn from their view two months ago, the markets now bet his next move will be to raise rates, as early as next March or April.

Most economists, however, dismiss that view as premature and overly aggressive.

Since late June, when the futures market was still expecting Bollard to cut the official cash rate (OCR) a further quarter of a percentage point to 4.75 per cent, the economic news has been mainly positive.

The labour market remains strong. Employment grew 0.8 per cent in the June quarter and the unemployment rate is the lowest for more than 15 years.

Retailers moved 1.5 per cent more merchandise in the quarter.

The housing market goes from strength to strength, keeping the construction sector at full stretch.

Business confidence has rebounded, the National Bank's survey recording gains for each of the past three months.

The dollar's relentless rise has given way to a period of consolidation.

Overseas, evidence of recovery led by the United States has strengthened, reflected in higher share prices and bond yields.

But on the other side of the ledger, the latest trade figures show export income in the June quarter was 12 per cent down on a year ago; currency hedging means the full effect of that may not be felt for some time.

National Bank economist Cameron Bagrie said the three main risk factors cited by the Reserve Bank in its June monetary policy statement had reduced markedly.

Business sentiment has recovered from the despondent levels recorded mid-year as the threat of Sars and electricity shortages receded.

But the Reserve Bank had assumed that confidence would pick up and had already built that into its forecasts, Bagrie said.

It also anticipated the stabilisation of the exchange rate.

And although the improved outlook for the world economy would be positive for New Zealand, doubts remained about how sustainable it would be, Bagrie said.

None of those factors warranted an interest rate track higher than the bank had presented in June, which included a modest rise in the OCR from late next year.

While money markets are pricing in at least two rises in short-term interest rates by the middle of next year, market economists are still split roughly equally between those who think rates will still be on hold then and those who think there is one more easing step to come.

Westpac chief economist Brendan O'Donovan said the markets could see recovery under way in the US and Asia and knew that in the past that had meant higher inflation and higher interest rates.

But this time it would be different because there was so much spare capacity around and the risks of imported inflation were minimal.

Instead, one of the surprises had been how much of the benefits of the stronger dollar in making imported goods cheaper had been passed on to consumers rather than used to rebuild retailers' margins, said O'Donovan.

The only significant and persistent source of inflation was the housing sector.

Westpac estimates house prices are overvalued by 7 to 9 per cent.

"The Reserve Bank will want to make sure this souffle doesn't rise too far and then collapse.

"The best recipe to prevent that is to hold interest rates up rather than cut them further."