Reserve Bank hints at higher interest rates

By PAULA OLIVER

Yesterday's hike in interest rates might not be the last in the short term.

The Reserve Bank yesterday lifted the official cash rate from 5.25 per cent to 5.5 per cent and refused to rule out further rises because of uncertainty around several important economic signals.

Economists had been split down the middle on whether the central bank's governor Dr Alan Bollard would hold rates steady or lift them.

Bollard's explanation was that the economy continued to perform strongly and was supported by improvements in the global economy.

Domestically, inflationary pressure remained strong and lifting interest rates was a prudent move to keep inflation within the target range over the medium term, Bollard said in a statement.

One of the factors taken into account in the decision was the Kiwi dollar's recent nosedive against its US counterpart.

Bollard made it clear that uncertainty still clouded the currency, and it was not known if the fall would be sustained. Mixed signals were also coming from the housing and construction sectors.

"Given these uncertainties, a further adjustment to monetary policy cannot yet be ruled out," Bollard said.

A further fall in net immigration numbers and delayed effects of the Kiwi currency's rampant rise coming through could dampen the inflationary pressures, he said.

One economist who found the day's events confusing was Westpac's Brendan O'Donovan.

He told the Business Herald that he felt Bollard had not made a good case for the move, and it appeared the central bank was overreacting to a short-term currency fluctuation.

"To me they haven't been particularly consistent," O'Donovan said. "The currency is all over the place in terms of its importance rating. They've given us all the reasons why they shouldn't go, but they've said they will and they might again. To me that doesn't stack up."

O'Donovan said that the fall in the Kiwi dollar appeared to be behind the decision. But because it was so unclear whether that would be sustained, a wiser approach would have been to wait a bit longer and see.

If the currency rebounded now the Reserve Bank risked underwriting a spike. It could then get stuck with higher interest rates and a higher exchange rate.

"It would only take one bit of bad data from the the US, and sentiment would change dramatically about the US Federal Reserve's next move," O'Donovan said. "It's a possibility. I just don't think it's a risk he [Bollard] should be taking on."

O'Donovan pointed out that forecasts were for a slowdown in economic activity.

The central bank opted to leave the cash rate untouched in its March review. Since then mixed signals have come through and softer-than-expected inflation in the March quarter prompted some observers to suggest the Reserve Bank would hold rates.

It began tightening in January with a 25-basis-point rise. At the time Bollard said he did not expect a large adjustment, and that he wanted to return interest rates to levels that were less stimulating. A neutral level is generally thought to be an OCR of 5.75 per cent or 6 per cent at the outside.

BNZ's chief economist Tony Alexander was not surprised by yesterday's move, and said he expected another rise in June. "Some of the risks they were seeing as putting downward pressure on inflation have disappeared. The currency is no longer at the high level, so I think they've pulled back on their fear of a major downturn in the export sector and falls in import prices."

Record levels of job ads, the housing market picking up again last month when interest rates were held steady, the continued shortage of labour and improving world growth were the combination of reasons behind the move, Alexander said.

"It's made them more confident that it's safe to remove the monetary stimulus."

He expected the latest rise to help slow the housing market.

Deutsche Bank senior economist Darren Gibbs said yesterday's decision was always going to be a close call. "They are concerned about inflation pressures in the non-tradeables sector. That's reasonably conventional for central banks."

Unless the currency went back up, it was a reasonable bet that the Reserve Bank would go for another rise in June. "We're saying it's a 60 per cent chance. That would take us to 5.75 per cent, and that's probably within the range of what the bank calls neutral."

New Zealand's rate is among the highest in the developed world, but the economy has been outperforming that of its trading partners.

Economists will probe labour market data coming out next month for clues to the next OCR review, and watch the currency closely.

Central bank rates

New Zealand 5.5%

Australia 5.25%

US Federal Reserve 1%

European Central Bank 2%

Bank of England 4%