Stronger terms of trade could drive interest rates up further, RBNZ says

Thursday 12th December 2013

Strong commodity prices, particularly for dairy products, could drive up interest rates more than currently expected if they continue to keep the terms of trade at elevated levels, the Reserve Bank says.

In an alternative scenario in today's monetary policy statement, the bank projected a more aggressive tightening cycle if global demand for New Zealand exports keeps commodity prices high and maintains an elevated terms of trade. The terms of trade were at a 40-year high in the September quarter as surging dairy prices, primarily driven by Chinese demand, raised the value of export receipts.

If proposed reforms by Chinese authorities go ahead, that could benefit New Zealand's export products over the coming decade, putting the terms of trade on an increasing trajectory rather a decline, as assumed in the bank's main forecast.

That in turn would increase pressure on productive resources and lead to stronger non-tradables inflation, needing a more aggressive policy response from the Reserve Bank.

The improving outlook would also drive up the currency, though that wouldn't detract from bigger interest rate hikes as the better trade environment would stoke domestic demand.

BusinessDesk.co.nz

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