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Bollard to take time out on rate hikes

Monday 13th September 2010

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Reserve Bank Governor Alan Bollard will take a pause from raising interest rates this week to assess the pace of the global economy, the flow-on effects from Canterbury’s earthquake and the failure of South Canterbury Finance.

Economists see a 60% chance Bollard will keep the official cash rate at 3% when he reviews monetary policy on September 16, having raised the rate from a record low 2.5% in two steps since June 10, according to a Reuters survey.

Based on the Overnight Index Swap curve, traders see 65 basis points of hikes in one year’s time. That’s down from more than 200 basis points in May.

The last time Bollard raised rates twice then stopped was in late 2005, when a strong kiwi dollar hurt exports and construction activity fell. He may prefer to wait until his January 27, 2011, review before resuming this time. In a speech last month, he told the Taranaki Chamber of Commerce the economic recovery was “fragile” and warned companies not to respond to as temporary spike in inflation by raising their prices.

“It appears the possibility of stifling the economic recovery is now the key policy risk in the short term,” said Nick Tuffley, chief economist at ASB, in a report.

"The earthquake serves to add to that uncertainty, and reinforces our expectations that the RBNZ will choose to keep the OCR on hold for at least the rest of the year.”

Holding interest rates pat would be a show of resolve from the central bank, which intends to look through the short-term effects of an increase in GST, ACC, the ETS and tobacco excise.

Bollard is more optimistic that some market economists that the short-term spike in inflation, seen reaching 5% in the first quarter next year, won’t drive up long-term pricing intentions.

“We suspect the real test of attitudes to inflation will come next year, once the inflation peak actually occurs,” said Brendan O’Donovan, chief economist at Westpac Institutional Bank.

The RBNZ’s survey of expectations released August 24 showed business managers raised their one-year-ahead expectations for the consumer price index to 3.9% from 2.9%, while lowering their view of inflation two years out to 2.56% from 2.8%.

Bollard’s next MPS comes about a week before gross domestic product is released for the second quarter. The economy probably grew 0.8% in the three months to June 30, according to a Reuters survey, less than 1.1% pace the central bank forecast in its June MPS. That would mark the second quarter where growth undershot the bank’s predicted track.

Since June, data has showed the unemployment rate has headed back up to a 10-year high of 6.8% and figures last week showed manufacturing output has weakened to an 11-year low.

The trade-weighted index of the New Zealand dollar reached 67.70 last week, the highest since late July. The 90-day bank bill was at 3.22%, having eased from 3.34% in July.

“We expect this to be only a short break within the RBNZ’s long-stated plan to return rates to more normal levels as the economy recovers,” Westpac’s O’Donovan said.

The June MPS indicated this “could mean an OCR as high as 6% by the end of 2012 – from a starting point of 2.5%,” he said.

“That’s a lot more tightening than the RBNZ has ever had to signal in any previous cycle.”

Businesswire.co.nz



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