Bollard tightens the reins

By BRIAN FALLOW economics editor

The Reserve Bank yesterday began what it expects to be a gentle tightening of interest rates.

Citing the pressure on resources including the labour market after two years of "impressive" growth, the bank raised the official cash rate 25 basis points to 5.25 per cent.

"It is now prudent to to begin returning interest rates to levels that will have less stimulatory effects on demand. By historical standards we do not expect a large adjustment in interest rates will be necessary," Governor Alan Bollard said.

The comment was taken to indicate that he has no intention of going beyond a neutral level of interest rates, where they are neither stimulatory nor constrictive. That is typically estimated at 5.75 per cent on the OCR, or 6 per cent at the outside.

Westpac, National Bank and Deutsche Bank expect Bollard to stop after one further 25-point hike in March.

ANZ, ASB, Citibank and UBS Warburg see a further move in April, and Bank of New Zealand at the hawkish end of the spectrum forecasts an OCR peaking at 6 per cent by the middle of the year. Even that would be a more modest tightening than the 100 basis point cycle in 2002, or 150 points in 2000.

"It's not likely to be necessary for the Reserve Bank to stamp on the brakes hard, given what we know is in the pipeline by way of weaker export incomes and slowing population growth," said ANZ chief economist David Drage.

The Reserve Bank had clearly been alarmed by the Institute of Economic Research's latest quarterly survey of business opinion - which reported acute skilled labour shortages, high capacity utilisation and cost and pricing pressures - and by the very strong housing-related pressures in the December inflation data, Drage said.

BNZ economist Craig Ebert said the Reserve Back had acknowledged the exchange rate as causing some pain, "but not enough to bring the economy to heel ... You can't rely on a continually rising currency to keep inflation under control. Eventually it has to wash out."

Deutsche Bank chief economist Ulf Schoefisch regards the Reserve Bank's inflation concerns as exaggerated. There was still more benefit to come from lower import prices flowing through to the consumer, even if the currency did not race up as it had in the past year.

"As for construction cost, yes things are tight but they are not getting tighter. That market is levelling off." Reference to the rapidly falling net inward migration was conspicuously absent from the bank's statement, he said.

"And with the currency being thrown around quite a bit, there was no need to pull the trigger now."