UPDATED: Bollard to slowly hike interest rates from middle of next year

Thursday 8th December 2011 1 Comment

Reserve Bank Governor Alan Bollard will probably start a slow track of interest rate hikes through the middle of next year as Europe’s sovereign debt woes only have a mild impact on the local economy.

Bollard held the official cash rate at 2.5 percent today, as expected, and reined in its forecast track for the 90-day bank bill, often seen as a proxy for the benchmark interest rate. The bank now sees the 90-day bank bill gradually rising through the second half of next year before settling at 4 percent in September 2013. That trims 30 basis points from the top of the forecast, and removes a sharp increase in the June quarter next year.

“The 90-day track is consistent with some gentle rises some time in the middle of next year,” Bollard told reporters in Wellington.

Westpac Banking chief economist Dominick Stephens and economist Michael Gordon said the central bank “is now signalling a gentle series of OCR hikes beginning in June 2011 and culminating in a peak 90-day rate of 4 percent.”

Traders are betting Bollard will raise the OCR just 1 basis point over the coming year, according to the Overnight Index Swap curve.

ASB chief economist Nick Tuffley kept his expectation the Reserve Bank will start hiking interest rates in December next year, though the forecast track of the 90-day bill implies a September quarter move.

Bollard said “it remains prudent for now to keep the OCR on hold,” with elevated debt in Europe threatening to cause a worldwide economic slowdown. That “tightness in international markets means funding costs for New Zealand banks will increase to some degree over the coming year,” he said.

Tougher international funding costs are “a particular concern due to the potential on borrowing costs for households and firms independent of changes in the OCR,” the bank said.

Bollard said core inflation has eased back, and underlying inflations sit within the bank’s target band of between 1 percent and 3 percent at about 2 percent. Wage inflation has remained contained with fewer settlements above 3 percent compared to 2008, though there’s also been a reduction in negative or zero wage changes in the past few years.

Inflation has remained in check through much of this year, with the consumer price index and producer price indices showing slower acceleration than expected. The spike in the CPI from last year’s GST hike has worked its way through, and underlying inflation has been stable at about 2.5 percent in the third quarter, according to government data.

Earlier this year, Bollard indicated he was keen to remove the extra stimulus he added in response to the February earthquake, though that was put on hold as financial markets tumbled after the United States’ credit rating was downgraded and the Euro-zone struggled to come to grips with the high level of debt among some of its members.

Markets are waiting for Friday’s European Union leaders’ summit in Brussels, where it’s expected the region’s policymakers will agree to a workable plan to integrate their economies and clamp down on government spending in a deal to address members’ elevated public debt.

The European turmoil prompted the Treasury to cut its growth forecast for the March 2013 year to 3 percent from 3.4 percent, though the government department is still more optimistic on the economy than the New Zealand Institute of Economic Research, which is picking 1.5 percent growth in calendar year 2012.

The Reserve Bank cut its growth forecasts with Europe’s woes weighing on New Zealand’s trading partners and as the Christchurch rebuild is delayed. The bank expects growth of 2 percent in the March 2012 year, down from a forecast 2.8 percent in the September statement, and 2013 expanding 2.9 percent, down from 3.1 percent.

Since the last monetary policy statement in September, New Zealand’s sovereign credit rating has been downgraded by Standard & Poor’s and Fitch Ratings due to the size of the country’s external debt, though Treasury the Reserve Bank are expecting household savings to improve as people use the record low interest rate to repay debt and improve their personal balance sheets.

Those downgrades had “little impact on bank funding conditions” though the Reserve Bank said a further credit rating cut could “elicit a more substantial market reaction.”

The National-led administration, which won a second term on Nov. 26, has promised to continue spending cuts as it looks to return the government books to surplus by 2015, and has agreed to implement a fiscal spending cap as part of its governing agreement with the Act Party.

Last week, the government’s books showed a bigger than expected operating deficit of $3.36 billion in the four months ended Oct. 31. The shortfall was put down to a smaller than expected income tax take, though corporate tax revenue was running ahead of forecast.

In November, a three-month slide in business confidence was arrested according to the National Bank Business Outlook as companies shook off fears the local economy will get caught up in a global downturn.

BusinessDesk.co.nz

Comments from our readers

On 8 December 2011 at 11:13 am Ivan said:

Hurry up and raise them, I'm sick of getting a low return on my investments. Why does it only have to be about the homeowner.