Bollard weighs how to rein in spending

By BRIAN FALLOW economics editor

If Reserve Bank Governor Alan Bollard raises interest rates tomorrow - and it's a toss-up whether he will, - the idea would be to cut the spending power of borrowers.

Some borrowers, anyway.

About half of all mortgages are at floating rates which are pushed up and down by what Dr Bollard does to the official cash rate.

They represent only 35 per cent of all residential mortgage debt by value, but that still leaves around $28 billion worth of home loans within Dr Bollard's reach.

An interest-rate hike of a quarter of a percentage point, if it sticks for a year, would take $70 million out of those borrowers' pockets. That is equivalent to about half a day's average retail sales. It would not bring the economy to a screeching halt.

But it would be felt. Households are thought to be more sensitive to interest rates than they used to be, because household debt is about twice as high in relation to incomes as it was in the early 1990s.

A rate hike would also push up the cost of a lot of business borrowing.

Some debt-funded transactions would be likely to be deferred. Economic activity would slow.

That is the whole point of raising interest rates.

This time, though, the economy is slowing already.

The high dollar is starting to eat into farmers' and other exporters' incomes and the chilling effects of that will reach Auckland next year.

Also, one of the drivers of the fading economic boom was the net inflow of migrants which added 1 per cent to the population at its peak in the middle of last year, boosting the demand for housing and the supply of labour. The inflow has dwindled to about half its rate since then.

So why would Dr Bollard want to add to the slowdown by raising the cost of borrowing?

Mainly it is because of the overheated housing market. House prices rose 22 per cent last year nationwide.

When that is combined with a tight labour market, as it is now, it spells danger for Dr Bollard, whose job is to keep inflation low.

The risk is that people, faced with higher housing costs, will seek and get pay rises which push up prices of goods and services generally.

But the housing market already shows signs of cooling down. Turnover has fallen for four straight months.

If Dr Bollard does raise rates tomorrow most economists think that will be it for this year.