Don't count on an interest rate rise, says BNZ

By BRIAN FALLOW

The money market is wrong to think that the Reserve Bank will raise interest rates soon, says the Bank of New Zealand.

Because of the weakness of the world economy, the Reserve Bank has got it right in easing by just 75 basis points and will not need to tighten again until maybe the September quarter next year, chief economist Tony Alexander said.

After what was taken to be the hawkish tone of last Wednesday's monetary policy statement, the debt market had been sold off.

The market was now pricing in a rise of 25 basis points for next year's first quarter, if not earlier, a further 25 points in the June quarter and yet another twist of the screw to 6.5 per cent by the end of next year.

By contrast, the Reserve Bank's projections have 90-day interest rates averaging 6 per cent next year and 6.25 per cent over 2003.

Ninety-day bills were trading at a yield of 5.85 per cent yesterday.

"You can maybe see some evidence of the market getting ahead of itself in the bond spread," Mr Alexander said.

"We are about 160 points above the US 10-year yield, well above the long-term average, and we don't see the fundamentals which would justify that."

Last week, the Reserve Bank said: "The current situation would point to an early increase in the official cash rate were it not for the risk that the international environment would turn out to be even weaker than assumed."

Since then, forecasts have again been revised down, with growth in New Zealand's 14 largest trading partners being cut to 1.9 per cent this year (from 2.1 per cent last month) and 3.2 per cent next year (3.4 per cent previously).

Taking some of the pressure off interest rates was the appreciating kiwi dollar, up 5 per cent against the US dollar over the past fortnight.

But Mr Alexander said the upward pressure on the exchange rate would ease off.

"The kiwi will appreciate over the next two years, and it will do it in a stop-start fashion.

"But the major part of the New Zealand dollar's recent strength has been US dollar weakness and people are getting a bit too negative on the US dollar in the short term."

The flipside of US dollar weakness would be euro and yen strength.

The Reserve Bank had scaled back its estimate of the potential (non-inflationary) growth rate to 2.5 per cent. "Are we going to run into that barrier in a worrying way for a while? Not really, given the world slowdown," Mr Alexander said.

The Reserve Bank expects growth of 2.5 per cent to next March and a modest pickup to 3 per cent the following year.

The 2.5 per cent growth forecast for the current year assumed that export volumes would rise 5.5 per cent, which the BNZ economists said was optimistic because of slowing world demand and coming after a bumper agricultural season.

Deutsche Bank argues that the Reserve Bank will need to be confident that a tightening is required before reversing this year's easing, for fear of damaging its credibility if it tightens and then has to reverse itself.

"Given than the Reserve Bank projects only a modest tightening cycle, there should be little urgency to raise rates," said Deutsche Bank economist Darren Gibbs.

Deutsche Bank predicts a 25 point rate rise in the March quarter.

WestpacTrust believes that another rate cut, in November, cannot be ruled out.

"Near-term GDP, wage and inflation numbers will continue to challenge the Reserve Bank. But in the end a global recession will win out."