Bollard takes a steady line

By BRIAN FALLOW

Reserve Bank Governor Alan Bollard left interest rates unchanged yesterday, surprising no-one, and was resolutely non-committal about whether the next move is likely to be up or down.

The conditional interest rate projections in the monetary policy statement show short-term interest rates flatlining at current levels over the next two years. That reflects the bank's view that the risk of developments that might require lower rates are "evenly balanced" with the risk of developments which would require higher ones.

Financial markets, focusing more on weakness in the global economy than the strength of the local one, had begun to price in an easing in March next year. Much of that was taken out in response to the statement.

Analysts are divided almost equally into three camps: those who think the bank's next move will be an easing, those picking a tightening and those who see no change for at least a year.

Although the bank expects economic growth to slow, the decline is from a pace of growth that is unsustainably strong.

Likewise, though inflation is forecast to fall, it is from a level uncomfortably close to the top of the 1 to 3 per cent target zone.

Echoing the analysis of private sector forecasters, the bank says that the domestic economy has proved stronger than it thought in August, but that is offset by a more tentative global recovery and much faster rise in the exchange rate than it expected then.

In particular Australia, which like New Zealand has been favourably out of sync with the rest of the world, helping to mitigate the global downturn, is looking more shaky, beset by drought, faltering consumer confidence and the risk of a boom-bust scenario in its housing market.

But though a more fragile global recovery will affect New Zealand economy through lower commodity prices, "we see the economy adjusting fairly well, with growth dropping to a little above 2 per cent", Bollard said.

"It is a pretty good response to a downturn, compared with the Asian crisis, a similar-sized shock. In that case growth dropped to nothing."

Bollard said the bank was starting to hear concerns from some exporters about the high level of the New Zealand dollar compared with the Australian, but ruled out any monetary policy response to that.

"We don't take the view that monetary policy is going to have a direct and predictable effect on the dollar and that's not the way we are running monetary policy."

Although overall inflation has remained above 2.5 per cent over the past year, the composition has changed.

"Tradeables" inflation, influenced by world prices and the exchange rate, has been abating, offsetting price rises in the non-tradeables sectors, notably domestic service industries.

Bollard said that the subdued nature of imported inflation was useful in keeping the overall CPI under control, but he denied he was counting on an appreciating dollar to contain inflation.

"We don't take a view that we find a high dollar a useful way of keeping inflation under control."

ANZ Bank chief economist David Drage said the Reserve Bank might be over-estimating the extent to which lower import costs would flow through to consumer prices. Strong local trading conditions gave firms the chance to rebuild margins which had been squeezed when the dollar was falling. Similarly favourable trading conditions increased the risk that wage rises would be passed on to consumers.

The bank's projected decline in inflation, to a little over 2 per cent by 2004, might therefore prove optimistic. If the geopolitical concerns overhanging the world economy dissipated, the next move in interest rates would be up, Drage said.

Deutsche Bank chief economist Ulf Schoefisch said that with inflation still in the top quarter of the target range, net immigration strong and a renewed upturn in the housing market any hint of an easing would have looked out of place.

"It could have given the market the impression that the changes to the inflation target and operating framework were not simply minor adjustments but were leading to a significantly looser approach. That could have been a potentially costly mistake," Schoefisch said.

The Reserve Bank of NZ