Brash's finger on interest trigger

By BRIAN FALLOW

Between the lines

Interest rates will rise this year - by 2 percentage points, according to the futures market.

Less clear is the timing of the Reserve Bank's progressive tightening of the screws.

Tomorrow is its first opportunity to raise interest rates. The prevailing view is that Governor Don Brash will let the opportunity pass and wait until March 15 to hike rates, but a rise now cannot be ruled out.

Just before Christmas we learned that the economy expanded 2.3 per cent in the September quarter. While much of that was a bounceback from a surprise contraction in the June quarter, it suggests the economy is expanding at about a 4 per cent annual rate.

That is about 1 per cent faster than the Reserve Bank thinks the economy can grow sustainably without overheating. Above-trend growth is fine as long as there is spare capacity in the economy, but the bank has already brought forward its estimate of when that slack will be taken up and some private sector economists expect it will have to do so again.

The anecdotal evidence is that retailers had a good Christmas. Consumer confidence is at a three-year high.

On the export side growth forecasts in New Zealand's trading partners are looking good and farmers have been enjoying the silver lining, so to speak, of the summer's rain clouds.

Adding to the pressure for Dr Brash to tighten is the expectation that the US and Australia will raise their interest rates next month, both of them going above ours. It is unusual for short-term interest rates here to be lower than theirs so any widening of the gap could put downward pressure on the kiwi dollar, not something the bank would welcome as it starts to fret about inflation.

But none of this amounts to a compelling case for the Reserve Bank to move tomorrow rather than in March.

It has been at pains to emphasise that its focus in setting monetary policy is medium-term. That is, it seeks to affect the balance of demand and supply in the economy one to two years ahead.

In that context, as WestpacTrust chief economist Bevan Graham argues, the eight weeks between now and the March Monetary Policy Statement does not make all that much difference. No irreparable damage would be done to price stability, he says, by waiting until March.

Furthermore, the bank has only just tightened - in November. It has indicated a strong preference for adjusting policy in the context of a full quarterly review of its economic forecasts. To move intra-quarter might risk being seen as a bit panic-stricken.

Managing such perceptions is one of the most subtle parts of the monetary policymaker's art. Above all Dr Brash wants to keep inflationary expectations down. He would want to reinforce the bank's official stance that it does not expect the inevitable oil-fuelled rise in the consumers price index to spill over into generalised inflation, and therefore we should not expect it to either.

In that context a trigger-happy tightening tomorrow could be counter-productive.