High hurdles for Brash

By Brian Fallow

WELLINGTON - As he tightens the reins on the economy more aggressively than many expected, there is more than usual interest in Reserve Bank governor Don Brash's monetary horsemanship.

There is a lot riding on him but like spectators at the show jump arena we can only size up the fences and hope for a Mark Todd performance.

Trying to figure out the height of the top rail for interest rates comes down to watching the economic indicators Dr Brash is watching and guessing what he will make of them.

As well as the various statistics and surveys which come along monthly or quarterly, there is one indicator which is constantly on the Reserve Bank's radar screen the exchange rate.

That is not only because of its effect on the price of imported goods but because a low exchange rate stimulates the export sectors of the economy in much the same way as low interest rates stimulate the domestic sectors.

Ulf Schoefisch, Deutsche Bank's chief economist in New Zealand and a former senior economist at the Reserve Bank, believes the exchange rate will pose a growing problem for Dr Brash.

The chronically high current account deficit is likely to be a source of persistent weakness in the currency.

Fine for exporters, but the Reserve Bank needs the dollar to rise to offset rising world commodity prices, especially oil, and rising world inflation generally.

The chances that the dollar will rise enough to do the inflation-countering work it did during the last upturn in the mid-1990s, or that the Reserve Bank is counting on this time, don't look good, Mr Schoefisch warns. The current account deficit is significantly higher. There will not be the same demand for kiwi dollars from overseas buyers of state assets, and the "New Zealand story" has lost a lot of its lustre in the eyes of international investors generally.

That means interest rates will have to do more of the work of "leaning against" inflation. The problem there, Mr Schoefisch says, is that while the domestic economy is strong it is less buoyant than in the mid-1990s, especially the housing market.

Households are carrying a lot more debt. "That suggests a return to short-term interest rates of 9 or 10 per cent would not just slow demand growth but most likely force the domestic sector into recession."

But for the Reserve Bank to trigger a recession in pursuit of inflation between 1 and 2 per cent and responding to a weak currency, would not be consistent with the newly revised Policy Targets Agreement Dr Brash's contract with the Government.

In the spirit of that agreement the best approach would probably be for the bank to accept an inflation rate above its preferred 1 to 2 per cent range but still below the 3 per cent ceiling the agreement reaffirmed, Mr Schoefisch argues.

But will this scenario be played out? Will Dr Brash be prepared to raise his sights to a 2 to 2.5 per cent inflation range for a prolonged period?

Only time will tell.

Here are some of the key dates on which early clues to the answer to that question will be released, over the next quarter or so:

* February 18. Statistics New Zealand's quarterly employment survey gives a sounding of wage growth in the December 1999 quarter. The labour market has been tightening significantly faster than the Reserve Bank forecast. The QES, and the labour cost index on February 23, will give an indication of how fast that is flowing through to wage inflation and rising unit labour costs

* March 10 Terms of Trade. This will tell us how much of our ever-swelling import bill reflects higher import prices and how much increased volumes. Imported inflation has not been a major issue over the past couple of years. But with the economy growing strongly again the competitive pressures on people selling imported goods to take a hit on profit margins rather than pass higher import costs on to consumers will be waning.

* March 15. The Reserve Bank's next monetary policy statement and review of the official cash rate.

ANZ Bank's chief economist Bernard Hodgetts is among a growing number of analysts who expect Dr Brash to go for another rise of half a per cent.

"A combination of strong activity growth, evidently not offset by stronger productivity growth, and the impact of a soft dollar on overall monetary conditions are the key factors," he says.

One indicator of whether that activity growth will stay strong will come the following week with the release of the WestpacTrust McDermott Miller consumer confidence survey. Monthly retail trade figures and household borrowing data have yet to show a slowdown from the two rate rises that have already occurred.

Also scheduled for some time in March is the Government's budget policy statement. This will be pored over for signs of a loosening of fiscal policy, which might be expected from a newly elected centre-left Government presented with a robustly growing economy. But the markets will not have a real handle on that until the budget proper in June.

"In my many years of observing political processes," Dr Brash said last Friday, "I find it difficult to recall a period when the calls for increased public spending were more intense - health, education, superannuation, defence, conservation, R&D and industry support can all present strong cases as to why increased spending in those areas is desirable."

But he went on to sound a warning note: "An improvement in the fiscal position tends in the short term to ease the pressures of monetary policy and hence on interest rates and the exchange rate. The opposite is also true."

\EE March 24. The December 1999 balance of payments. The trade figures are going from bad to worse, on top of a high and structural deficit in investment income. The current account deficit is likely to approach 8 per cent of GDP by the March 2000 quarter and may not improve quickly after that, Mr Hodgetts says.

\EE April 17. The CPI for March will attract more than usual attention after the unexpectedly low 0.2 per cent figure for December. Was that an aberration or will the pundits be confounded again?

This time round the Reserve Bank's monetary policy committee will have the benefit of the latest inflation figure before they consider (on April 18) whether to raise the official cash rate again.

The same week is also likely to see the NZIER's quarterly survey of business opinion, with its information on the state of firms' order books, and their pricing, hiring and investing intentions.

The QSBO also surveys capacity utilisation in the manufacturing and building sectors which, along with the employment data from the household labour force survey (next due on May 4), helps form the Reserve Bank's view of how much slack there is in the economy.

"It is abundantly clear that the bank now believes the economy is growing at close to full capacity," Mr Hodgetts said. "In these circumstances a pick-up in inflation is seen to be only a matter of time."