Rise shelters dollar from global trend

By Brian Fallow

WELLINGTON - A desire to shore up the New Zealand dollar seemed to be the key factor behind the Reserve Bank's earlier-than-expected interest rate rise on Wednesday, says Deutsche Bank chief economist Ulf Schoefisch.

The inflation and interest rate outlook the Reserve Bank published in November assumed that the currency would steadily appreciate over the next two years, reversing its decline over the past two.

So far, this shows little sign of materialising, with the upward pressure from expected rises in interest rates offset by downward pressure from concerns about the current account deficit and sluggish commodity prices.

Announcing the 25-basis-point rise to 5.25 per cent in the official cash rate on Wednesday, Governor Don Brash cited among the factors the strong growth in the world economy which is prompting interest rate rises around the world.

Mr Schoefisch argued that with the US and Australian central banks almost certain to raise interest rates early next month, the New Zealand dollar would have come under increased pressure from wider interest rate differentials if Dr Brash had waited until March to tighten.

But doesn't the fact that inflation was almost imperceptible in the December quarter, despite a substantial fall in the dollar last year, show that concern about the inflationary effects of a weak currency is a phantom?

No, said Mr Schoefisch.

The lack of inflation as a result of the dollar's depreciation since 1997 was due to world prices declining at the same time, combined with a reluctance to pass on any increases in the price of imported goods because New Zealand was in recession or climbing rather tentatively out of it.

Mr Schoefisch said that as the domestic economy gathered strength and world inflation gradually built, the Reserve Bank was rightly concerned about imported inflation if the currency did not rise.

What inflation there was in the December quarter was more in the tradables than non-tradables sectors of the economy. The Reserve Bank splits the components of the consumers price index into tradables and non-tradables, the former being those sectors which are exposed to the international marketplace.

The biggest rise was in petrol prices - up 6.3 per cent on top of a 7.7 per cent rise in the September quarter.

Meat prices were up 1.4 per cent, reflecting improved export prices, but that was more than offset by a weather-related fall in fruit and vegetable prices.

The New Zealand dollar's fall against the yen since the middle of last year was reflected in a 2.7 per cent rise in new car prices, but used car prices were flat.

On the other hand, the weaker dollar was not reflected in higher prices for household appliances, which actually fell 1.3 per cent in the quarter.

Statistics New Zealand suggested that parallel importing might account for some of that.

On the non-tradables front, telephone call charges were down 1.8 per cent. Electricity charges fell 1.5 per cent for the quarter, but that reflected a switch from winter to summer rates in the South Island. Over the year, electricity prices rose 3.2 per cent.

WestpacTrust chief economist Bevan Graham said that despite the fact that surveys had found increasing inflation expectations and price-raising intentions in the latter part of last year, the December CPI figures showed no sign of oil price rises and the economic recovery causing generalised pricing pressures.

"The only area showing the impact of rising economic activity is the purchase and construction of new dwellings [up 0.6 per cent]. The pace of construction over 1999 to the September quarter has been phenomenal and is now causing a few resource pressures," he said.

But towards the end of the year the trend had been tapering off.

Overall the big price spikes expected for the last half of 1999 and the beginning of 2000 have largely come through, Mr Graham said, and been adequately compensated for by falls in other areas.

"The first half of 2000 will only be affected by large increases in tertiary education fees, rises in air fares, and possibly further car price rises on the back of the weak exchange rate with the Japanese yen."

Those spikes would be much smaller than those in 1999, he said.

On the other hand, as spare capacity in the economy was taken up over the first half of the year, generalised inflation pressure would build up.

The reasons Dr Brash gave for raising interest rates were valid, Mr Graham said.

"Relative to the view in November, inflationary pressures were going to arrive earlier [due to] strong domestic and world growth and expectations of offshore interest rate increases."

ANZ Bank chief economist Bernard Hodgetts said, however, that the information in the CPI on "core" inflation pressures called into question the extent to which inflation had been expected to rise during the next 12 to 18 months.

"Taken with the relatively weak September quarter CPI and putting aside the one-off impact of the sharp rise in world oil prices, there was little if any inflation over the second half of 1999," Mr Hodgetts said.

Inflation over the second half of last year had turned out to be nearly 1 per cent lower than the Reserve Bank's November forecasts.

"The evidence is mounting that structural changes to the economy in recent years - such as permitting parallel importing, and other changes designed to foster competition - are continuing to suppress inflation in areas which would otherwise be picking up at this stage.

"This could lead the Reserve Bank to conclude that the non-inflationary growth rate for the economy over the next few years will be higher than previously expected."