9.40am
Reserve Bank Governor Alan Bollard hiked interest rates today and signalled a series of further rises later this year to counter a predicted inflation shock.
In his quarterly Monetary Policy Statement, Dr Bollard hiked the Official Cash Rate (OCR) to 5.75 per cent from 5.5 per cent, a move certain to be matched by retail banks as early as today.
Fuelled by oil prices and household spending, inflation is seen jumping outside the bank's 1-3 per cent target range early next year for the first time since June 2001.
Dr Bollard said the predicted rise in inflation to 3-1/4 per cent early next year was not a breach of the bank's mandate with the Government as the bank is only required to keep within the target band "on average over the medium term".
Improvements in global demand, rising commodity export prices and the recent fall in the exchange rate pointed to stronger activity than the bank forecast in March.
"Moving interest rates higher is thus appropriate to ensure that medium-term inflation remains within the target range," Dr Bollard said.
"At this stage, further increases in interest rates look likely to be needed over the year ahead, but to a modest degree by historical standards."
Economists had fully expected a rate rise today and most were expecting one more rise in the next review in July.
However, Dr Bollard's use of the plural in reference to future rate rises is something of surprise to market watchers.
The bank now projects wholesale bank rates to rise to 6.5 per cent, which suggests variable mortgage lending rates are likely to rise to 8.5 per cent from 7.25-7.75 per cent at present.
The RB projects inflation, currently at 1.6 per cent, to reasonably quickly drop below 3 per cent following its spike up, but it is still forecast to remain at 2.75 per cent through 2006 and 2.25 per cent in 2007.
Dr Bollard said it would be inappropriate to attempt to offset the "short-term" increase in inflation with a heavy handed use of monetary policy. But he did issue a warning should price setters misbehave.
"We will need to remain alert to signs of more enduring effects that could arise if wage or price setting behaviour starts to change.
"Were that the case, additional monetary policy pressure might be required to keep medium-term inflation pressures in check."
New Zealand already has the dubious claim to having the highest interest rates in the developed world and today's announcement is likely to again see the New Zealand dollar appreciate.
The US official rate is still at 1 per cent despite rapid economic growth, although the Federal Reserve is expected to lift its rate at the end of the month.
Australia's Reserve Bank left its rate steady on 5.25 per cent this month while Britain is forecast to lift its rate later this month to check its surging economy.
The RB is forecasting economic growth here to slow from 3.5 per cent this year to just 3 per cent next year and 1.75 per cent in 2006 -- unchanged forecasts from March. The forecast for next year is slightly more optimistic than Treasury's budget forecast but the slowdown in 2006 is more rapid.
Dr Bollard expressed concerns about rising inflation expectations. The bank estimated domestic inflation (excluding prices for imported goods) at around 5 per cent.
Employment growth and household wealth had risen faster than anticipated.
"Strong inflation in some domestic industries, such as housing and construction, over quite a sustained period raises the question as to whether medium-term expectations have started to edge up."
Dr Bollard said the recent easing of the New Zealand dollar had had less of a braking effect on the economy than had been forecast.
The dollar is expected to come down although the bank admits much depends on the US dollar and that is something of a lottery.
Oil prices are assumed to fall back to US$30 a barrel from the current price of just under US$40, but if that does not occur then economic growth will be slower.
Exporters will be supported by what the bank expects to be a fairly conventional world recovery and strong commodity prices. Export growth is seen picking up from 1 per cent this year to 3-4 per cent over the next three years.
New Zealand First leader Winston Peters damned the move as "panic" and said the country was "heading for the bad old days when (National Party leader) Don Brash was governor, strangling the life blood out of the economy".
"New Zealand already had the highest interest rates in the developed world and the latest hike will simply make life harder for people with mortgages and thousands of businesses," he said.
"The governor's warning that interest rates will rise further in the year ahead signals another increase in the exchange rates and more problems for our international trade."
Economists said the MPS was generally as expected although more "hawkish" in tone.
"Where the market may raise an eyebrow is firstly the CPI, which is forecast to rise through three per cent, and the 90-day bill forecast, which looks reasonably aggressive.
"I think that certainly implies the governor is looking at one or two more rate rises," said Goldman Sachs JBWere economist Bernard Doyle.
- NZPA
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