Soft and gentle world of finance

By Brian Fallow

Between the lines

The evidence is mounting that it will be next year before the Reserve Bank feels the need to start raising interest rates.

Business confidence surveys show few firms intend to raise their prices, and expectations of general inflation are at historically low levels.

This augurs well for the mutually reinforcing relationship between cautious price and wage-setting behaviour by business, on the one hand, and a kinder, gentler Reserve Bank on the other.

Bank of New Zealand economists see the Reserve Bank as having become more flexible and less interventionist as inflation expectations have fallen and the inflation target has widened.

ANZ Bank economists add the point that one consequence of the sharp rise in household debt over the 1990s has been to make people more sensitive to interest rate changes, so that it would take a smaller rise in interest rates to dampen demand and inflationary pressure.

The upshot hopefully will be a more sedate approach to monetary policy, making the next business cycle less of a roller-coaster rise.

The financial markets, however, appears to be sceptical, judging by 90-day bill futures. They have priced in a rise in the cash rate from the present 4.5 per cent to 5.25 per cent by the end of next March and 6.5 per cent by the end of the year 2000.

But the BNZ's economists are among those who expect the tightening to be later and gentler than that.

Recent indicators still testify to a limping recovery, with the export side of the economy unable to take much weight.

There have been some signs of a loss of momentum in the domestic economy: lacklustre retail sales and ebbing (though still positive) business confidence.

On the other hand, imports both of consumer and capital goods are showing robust growth, while building consents are strong even if the trend is flattening off.

Crucially, the outlook for exports has improved, with consensus forecasts for growth in New Zealand's trading partners steadily improving, while the exchange rate remains weak.

That is a two-edged sword, however. Prolonged currency weakness would encourage the Reserve Bank to raise interest rates, to prevent overall monetary conditions from becoming too stimulatory.

But the ANZ, for one, believes the dollar will recover sufficiently this year to prevent this. Improving prospects for world growth, they say, are already underpinning commodity prices, which will flow through to an appreciation of "commodity currencies" like ours.

Two influences may moderate, or at least delay, that effect, however.

One is the prospect that the current account deficit will blow out to around 7 per cent of gross domestic product - not a good look.

The other is political uncertainty as the election looms.