Brash softer than expected

By BRIAN FALLOW

WELLINGTON - There were cheers among the catcalls that greeted the Reserve Bank's monetary policy statement yesterday, which was considerably less hawkish than many market economists had expected.

As expected, governor Dr Don Brash raised the official cash rate 50 basis points to 5.75 per cent and raised his forward interest rate track, compared with November, to reflect a weaker exchange rate.

But the tone of the forecasts was softer and more tentative than expected, as though there were more doubts than usual about the outlook and Dr Brash was inclined to give the economy the benefit of all of them.

The bank has revised down its GDP growth forecasts for the next two years, reflecting stronger than expected growth over the past six months.

But it still has growth continuing at an average 3.5 per cent over the next three years. Despite that above-trend outlook, it forecast inflation to stay within the 1.5 to 2 per cent range.

National Bank chief economist Brendan O'Donovan welcomed the approach of getting the interest rate increases over early, then waiting and seeing. The rises were needed to return conditions from stimulatory to neutral.

There were strong reasons to think the domestic recovery would not be as strong in this cycle as it was last time, he said. Residential property indicators, for example, already showed interest rate rises biting.

Mr O'Donovan said the bank was finally paying more than lip service to the uncertainty about how far a weak currency feeds through to higher consumer prices for imported goods.

"Retailers are going to struggle to recapture the margins [squeezed when the currency was falling]. It is just too competitive a market."

The financial markets had priced in far too aggressive a tightening, Mr O'Donovan said.

But Deutsche Bank chief economist Ulf Schoefisch said the Reserve Bank was setting itself up for disappointment, with the risk of significantly higher inflation than it was forecasting from imports and the labour market.

"They say growth is already slowing. What about the fact the monetary conditions index over this year on average will be 150 points lower? Does that have no effect on growth?"

Bank of New Zealand chief economist Tony Alexander dismissed as a "Nirvana scenario" the Reserve Bank's belief that the policy tightening it is projecting will be enough.

"We think they will have to move maybe 1 per cent more than that."

The Reserve Bank's projected track for interest rates has 90-day bills averaging 6.6 per cent over the second half of this year, staying at or above 7 per cent through 2001 and 2002.

Dr Brash expected some disappointment in the markets about the forward track of monetary conditions.

"There are arguments on both sides. One could envisage circumstances where we would need to tighten the cash rate more aggressively, for example if household spending grows more strongly or if the exchange rate remains low despite rising commodity prices.

"But there are also reasons pointing in the other direction.

"Perhaps we will find that the economy can grow more quickly than we now expect without inflation, as central banks in other developed countries have found in the last few years. To date we have seen little evidence that actual inflation has begun to turn up."