Steps in both directions

By BRIAN FALLOW economics editor

Acting Reserve Bank Governor Rod Carr produced a one step forward, two steps back decision on interest rates yesterday.

The step forward was to deliver the expected 25 basis point increase in the official cash rate.

The two steps back were a retreat from the hawkish outlook for interest rates which he delivered in the May monetary policy statement.

This has widely been credited - or blamed - for drawing a tsunami of cash New Zealand's way, driving up the exchange rate.

"Since May there has been a much sharper rise in the exchange rate than allowed for, which has had the effect of tightening monetary conditions," Carr said.

"If the exchange rate appreciation is sustained or goes further, some heat will be taken out of future inflation pressures."

That would reduce the extent to which interest rates might need to rise in the months ahead.

He also cited the debilitated state of world equity markets and the fragility of the American economic recovery.

The Bank of New Zealand said that was obviously high on the list of growth risks for New Zealand, "although as last year proved the global numbers do not necessarily translate to New Zealand's growth outlook".

Market economists now expect the cash rate to peak at 6.25 per cent - 50 points above its level after yesterday's increase - by the end of the year.

But the market is still pricing in a further rise, to perhaps 6.75 per cent by the end of next year.

"We consider that too aggressive," said Deutsche Bank chief economist Ulf Schoefisch.



The kiwi dollar moved little during the day after openings at 48.8USc.

WestpacTrust chief economist Adrian Orr agreed that the cash rate would peak lower than the the "bonanza" the Reserve Bank indicated in May.

But he believed the projections would still point up.

Domestic demand pressures remained strong, Orr said, citing retail sales, construction and migration data coupled with high inflation expectations, a positive output gap, high use of capacity and a tight labour market.

Strong consumer confidence indicated that so far the impact of a stronger dollar had been offset by higher local asset prices, including housing.

"The recent rise in the New Zealand dollar and the decline in commodity prices brings export receipts from a stellar level to one that remains above average - certainly ahead of the average," Orr said.

Carr said there were promising signs inflation would peak in the next two quarters a little lower than expected.

Deutsche Bank expects the Reserve Bank to project inflation to fall to around 1.5 per cent over the next 12 months, from a peak of 2.7 per net in the June quarter.

Schoefisch said: "While the relatively high inflation figure expected for the June quarter - 1 per cent quarter on quarter - may look disturbing at face value, it includes petrol price increases and excise taxes, but virtually none of the New Zealand dollar appreciation."