By Kate Perry of NZPA
Friday 21st October 2005
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In line with global movements by central banks, the RB is all but certain to raise its key interest rate when it meets on October 27, in a bid to counter inflation and splash cold water on New Zealanders' debt-fuelled spending spree.
"Global central banks are sending a remarkably unified warning about the threat to core inflation from high energy prices and more have begun to tighten policy," said David Hensley, global economist at JP Morgan in New York told Reuters this week.
After months of hawkish talk from the RB, culminating in a hard-hitting speech by governor Alan Bollard last week, the market has priced in a 25 basis point increase which would bring the official cash rate up to 7%.
Westpac chief economist Brendan O'Donovan said the RB had been talking tough for so long, if it failed to raise rates it would be seen as "the boy who cried wolf".
A raft of economic data has supported the RB's hawkish stance, including blow-outs in both the current account deficit and inflation.
The release of the Consumer Price Index (CPI) this week showed inflation was up 1.1% in the September quarter and 3.4% for the September year.
The annual inflation rate breached the Reserve Bank's target band of 1% to 3% for the first time since the June quarter of 2001. The RB is mandated to keep inflation within the range `on average, over the medium term'.
Oil prices have fuelled inflationary pressures, with benchmark crude oil prices sticking above $US60 a barrel since August, more than double the asking price two years ago.
These record oil prices have contributed to headline inflation rates spiking to multi-year highs in both the US and Europe.
US Federal Reserve officials have recently been talking up the likelihood of further interest rate rises. The Fed has already implemented 11 straight increases over the past 15 months which have pushed up benchmark short-term US interest rates 2.75 percentage points to 3.75%.
European Central Bank officials have also warned that euro zone rates - at 2% for more than two years - will also rise if wage pressures build or core inflation climbs.
The Bank of Canada this week hiked rates 25 basis points to 3%, its second increase in two months as it struggles to contain inflation within its target band.
Back home, oil prices were the main contributor to the CPI increase. But stripping out petrol price increases, the CPI would have risen 2.9% for the year - still within spitting distance of breaching the target.
So the hike cannot be placed totally at the door of global oil prices. Big spending New Zealanders have also played a fairly significant part.
An interest rate increase is one way Dr Bollard can curb over-exuberant household spending.
New Zealanders' arms have proven much longer than their pockets in recent years and many households, encouraged by rising house values, have not hesitated to rack up debt to fund their spending.
In his no-nonsense speech last week, Dr Bollard said New Zealand had the worst savings rate in the OECD.
We are not only failing to save, we are actually "dis-saving". Meaning we are spending more than we earn - with aggregated figures showing the average household is spending 112% of their income.
In many cases, this spending is being funded by home-owners "unlocking" equity in their houses as property prices have boomed.
Dr Bollard said this practice was dangerous due to the cyclical nature of the property market and "unrealistic expectations" by home owners.
But home owners' expectations have been buoyed by statistics which show the long-touted bursting of the property bubble has yet to materialise.
Figures out this week from the Real Estate Institute show seasonably adjusted sales turnover increased 6% in September, while houses took on average two days less to sell. The median price held steady.
New Zealand Exchange (NZX) chief executive Mark Weldon, who has long expressed exasperation with New Zealanders' preoccupation with bricks and mortar, said over-spending was disturbing from a medium-term perspective.
"A) because the dis-saving does not result in investment; B) because the dis-saving tends to be spent on consumptive items which tend to be imports, which tends to drive the current account deficit," Weldon said.
Adding pressure to the RB, the current account deficit, which measures the country's transactions with the outside world, is currently sitting at around 8% of GDP (gross domestic product).
Dr Bollard has also warned that any planned splurges by the newly announced Government could worsen economic imbalances and the current account problem and lead to more interest rate rises.
Labour had to make a number of policy concessions to get the numbers to form government. These include pandering to Winston Peters on the issue of superannuation - agreeing to lift the rate from 65% of the average wage to 66%, which is expected to cost about $80 million a year. Labour also agreed to increase police numbers by 1000, instead of 250 as planned - at a cost of $75 million a year.
New Revenue Minister and United Future leader Peter Dunne wants to get rid of the proposed carbon tax and reduce the company tax rate to 30c in the dollar. Together these initiatives could cost $1.15b in lost revenue. On top of this are Labour's plans to scrap interest rates on student loans for graduates who stay in New Zealand, and the introduction of the Working for Families package.
Oil prices, and consumer and government spending aside further rate rises past October are not necessarily on the cards.
New Zealanders' preference for fixed-term home loans means that monetary policy takes a long time to take effect. Westpac's O'Donovan said this means the RB should be setting monetary policy with an eye to inflation in 2007, not current inflation levels.
"Patience is a virtue. Past monetary actions should be allowed time to have their effect, as should the natural economic stabilisers in the economy," O'Donovan said.
If patience is a virtue, so too is frugality. And we don't seem to have exercised much of that lately.
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