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It's a close call on interest rates this week

By Jenny Ruth

Monday 26th January 2004

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 Jenny Ruth
Most economists still expect Reserve Bank governor Alan Bollard will leave rates unchanged this week but a pullback in the New Zealand dollar's relentless rise and a worse than expected December quarter inflation outlook have made this less certain.

Bollard's official cash rate (OCR) currently stands at 5%.

Stephen Toplis, head of market economics at Bank of New Zealand, says that while his firm's official view that Bollard will do nothing yet, "It's a very close call. If they were to move (raise rates) in January, it would come as no surprise to us whatsoever," Toplis says.

He notes that the trade-weighted index (TWI) measure of the New Zealand dollar has slipped from more than 68 points a bit over a week ago back to 66.28.

"That's a big difference in percentage terms and it's enough to add uncertainty" to Bollard's decision on Thursday.

Westpac Bank economists take a similar view, noting that last week's consumer price index showed a 0.7% rise in the December quarter compared with the central bank's forecast of 0.4% and putting the annual inflation rate at 1.6%. They also note that increases in home ownership costs accounted for more than half the quarterly increase, a factor in favour of raising rates.

The Reserve Bank is charged with keeping inflation between zero and 3% over the medium term.

While most economists still expect rate rises later this year, Westpac sees "a chance of no interest rate rises at all if the New Zealand dollar increases much further."

National Bank's economists describe the Reserve Bank as being in a quandary of wanting to quell strong domestic activity, particularly in the housing market, but needing to hold off raising rates because of the currency.

"The bank cannot afford the reputational risk of hiking the OCR and then watching the New Zealand dollar push through 70 (US) cents," they say. The New Zealand dollar is currently trading at 67.12 US cents.

ANZ Bank's economists says Bollard "will be unlikely to want to foster further substantial New Zealand dollar strength by raising the OCR prematurely." Nevertheless, the prospect of mounting inflationary pressures could force his hand.

Anthony Byett, chief economist at ASB Bank, is more certain that Bollard won't be doing anything this week. Other economists are reading too much significance into day-to-day currency movements, he suggests. "The TWI has consistently been higher than the Reserve Bank has assumed."

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