Rates dilemma as dollar climbs

By BRIAN FALLOW

There is a 50-50 chance Reserve Bank Governor Alan Bollard will cut interest rates in March to offset the impact of the rampant New Zealand dollar, the Bank of New Zealand says.

Since the New Year the kiwi has appreciated more than 3 per cent against the United States dollar and more than 2 per cent on a trade-weighted basis.

Although the Reserve Bank's November economic forecasts assumed a further rise, the dollar has already far outstripped that and is now nearly 7 per cent higher than the average level for the first half of this year built into the forecasts.

The bite that takes out of exporters' incomes will tend to slow the economy and, other things being equal, would argue for an offsetting cut in interest rates.

"Were it not for the strength of the domestic economy an easing now would be an absolute gimme," says BNZ's head of market economics, Stephen Toplis. "But currently all the anecdotal evidence is that things at home are very strong, with retail sales over Christmas strong and housing market activity solid."

The last thing Bollard would want to do is throw extra fuel on the fire of a very hot domestic economy.

"In particular [he] will not wish to create the same sort of housing bubble that has been seen elsewhere around the world."

In November the Reserve Bank had been as neutral as it could be, Toplis said.

"What has changed since then is the dollar. Therefore if they are going to be entirely consistent you would have to say that if they are moving anywhere it is to an easing bias."

Talk of an easing any time soon is not the mainstream view, however.

Ninety-day bank bill futures are pricing in almost no chance of an easing this year and many economists believe the Reserve Bank's next move will be to raise rates.

Westpac chief economist Adrian Orr believes Bollard will raise rates, but not until the second half of the year.

A weaker US dollar is a necessary part of the US recovery, Orr argues, which in turn will be positive for world growth and the New Zealand export sector later in the year.

Meanwhile there is enough momentum in the domestic economy to "see us right" until then.

Deutsche Bank is among those who think the next move in interest rates will be down, most likely in the September quarter.

Reduced farm incomes and a declining boost from net immigration will slow the economy to a below-trend rate of growth this year, it says.

With the economy currently running above its sustainable capacity that slowdown is necessary if inflation is to settle comfortably within the 1 to 3 per cent target range over the next 18 to 24 months.

"Therefore before contemplating easing we think the bank will want to see more compelling evidence that this forecast will be realised than has so far been the case," Deutsche Bank said.