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Bollard set to raise OCR as inflation spike looms

Wednesday 9th June 2010

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Reserve Bank Governor Alan Bollard may deem there’s sufficient cause for concern from resurgent inflation in New Zealand to look through turmoil in global financial markets and hike interest rates tomorrow.

Bollard will raise the official cash rate by a quarter point to 2.75% when he releases his quarterly Monetary Policy Statement at 9 a.m. in Wellington tomorrow, according to a Reuters survey. Of 18 firms surveyed, 15 predict a 25 basis point increase in the OCR, one forecasts a 50 bps hike and two say Bollard will wait until July to move.

Tomorrow’s decision promises to have more bite than when Bollard last raised the OCR on July 26, 2007, when he lifted the rate to 8.25%, the highest since the benchmark rate was introduced in 1999. The average mortgage duration was sitting at around 12 months in March this year, while it peaked at almost two years in 2007.

Domestic economic conditions point to a rate rise tomorrow. Increases in goods and services tax and levies such as the Emissions Trading Scheme are expected to push the consumer price index well above 5% by the first quarter of calendar 2011. Business confidence measured by National Bank’s own-activity index is at the highest in more than a decade and hiring intentions are at an 8-year high.

The jobless rate tumbled to 6% in the first quarter from 7.1% three months earlier, a record drop. Stronger commodity prices have underpinned Fonterra Cooperative Group’s forecast for a higher milk payout next year and the kiwi dollar is trading near an 11-month low against the greenback, ensuring farmers capture more of the benefits of higher world prices.

At the same time, Europe’s debt crisis has ballooned into a greater event than the Reserve Bank was envisaging in its March statement and China is making louder noises about its determination to cool the world’s fastest-growing major economy, putting a question mark over the pace of global growth.

“If it was a decision based solely on domestic events, we feel the RBNZ would be comfortable starting to tighten,” said Philip Borkin, economist at Goldman Sachs JBWere, in his MPS preview. Still, “it is recent financial market ructions that are the ultimate gatekeeper for whether the RBNZ chooses to hike or not.”

Borkin expects the OCR to be raised to 2.75% tomorrow.

The central bank will increase the OCR by 1.65 percentage points over the next 12 months, based on the Overnight Index Swap curve, bringing the benchmark rate to more than 4% in a year’s time.

By then, the OCR will be back up at a more neutral level, from the current stimulatory record low level. As Bollard said in his April 29 statement: “We expect to begin removing policy stimulus over the coming months, provided the economy continues to evolve as projected.”

Deutsche Bank chief economist Darren Gibbs says the MPS will include an “upbeat outlook for the real economy.”

He cites a recovery in most trading partner nations, better prices for New Zealand’s exports, an improved labour market, a more expansionary fiscal policy and an increasingly robust business sector.

“The decision to begin normalising policy settings will be further supported by a markedly higher projection for inflation over the next 18 months,” driven by the Oct. 1 increase in GST to 15%, he said.

“Whilst the RBNZ can ignore the first round price impact of this tax change, it cannot ignore the attendant risks to inflation expectations, and its rhetoric should reflect this,” he said.

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