KEY POINTS:
Nobody will welcome the decision by the Reserve Bank Governor, Alan Bollard, to raise the official cash rate by 25 basis points to 7.5 per cent. Higher interest rates spell tougher times for those in business and, to varying degrees, those holding mortgages. Yet there was an inevitability about Dr Bollard's decision. While many with vested interests cautioned against a rise, market economists were virtually unanimous it would occur. Indeed, it had to take place, not only from the viewpoint of an overheating economy but to safeguard the Governor's credibility.
For most of the period since December 2005, when the official cash rate was last raised, Dr Bollard has warned repeatedly of the need for a slowdown in the housing market and consumer spending. His campaign reached a peak in January when he indicated that further tightening was extremely likely unless there were clear signs of a moderating market. What he got was an inflation-fuelling upswing, underpinned by banks' readiness to lend at very low margins, and strong growth in household incomes.
Already, there have been murmurings that Dr Bollard has not moved quickly enough to address the housing market's extraordinary resilience. Some argue that by not tightening last October, as two-year loans taken out during a period of extreme banking competition expired, the Governor missed his best opportunity. A failure to act yesterday would have invited ridicule.
The Reserve Bank's problem, of course, is that raising the official cash rate, as has happened 10 times since January 2004, has been proved a slow and largely ineffectual means of cooling housing investment. Those most disadvantaged, thanks to a higher exchange rate, have been exporters. Recent financial-market volatility, which has led to an easing of the dollar, may have made it easier for the Reserve Bank to raise the official cash rate at this time. But that is only a palliative. The enduring problem, given the preponderance of fixed-rate mortgages, is that increases in the official cash rate, or the threat of a further rise, have little impact on those in the housing market.
Therefore, while the Governor warned yesterday that "further tightening may be required", he supplemented this with advice that the Reserve Bank was considering other measures to rein in that market. These involve enforcing existing capital gains tax rules and changes to bank capital adequacy requirements. The first would see the Inland Revenue Department addressing the motivation of many property investors, rather than accepting glib denials. The second would mean increasing the amount of capital that banks must set aside to cover their lending on property.
The proposals reflect the Reserve Bank's intense frustration with the debt-fuelled housing market. Both would require the support of the Government to take flight. There is likely to be much blanching over any tightening of the tax rules, in particular. The Government's instinct will be to shun this, as it dismissed the concept of a mortgage rate levy. But, in reality, it cannot afford not to respond to the Reserve Bank's concerns.
In delivering this statement, Dr Bollard has virtually conceded that the official cash rate is a blunt instrument, and that the housing market has had little reason to heed his repeated pleas. To change that mindset, and to tackle inflationary pressures with greater agility and adroitness, he needs extra weapons. If he does not get them, businesses, especially those heavily involved in exporting, will continue to bear the cost. It is now abundantly clear that the Reserve Bank faces much-changed circumstances. The Government would be lax not to supply the ammunition to tackle them.
