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Opinion: Will Bollard's tough call tip economy into recession

By Simon Louisson of NZPA

Friday 11th March 2005

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Alan Bollard admitted his decision yesterday to raise interest rates was the toughest since his appointment as Reserve Bank Governor nearly three years ago.

"That's because we are around the turning point, we have got very strong inflation pressure but we don't want to drive a contraction through the economy," he explained.

There's the rub. It still seems incongruous as it did all last year when he lifted rates six times, that rates are hiked when the economy is forecast to turn down sharply next year and beyond.

Already with the highest interest rates in the developed world and the currency at its highest level since it was freely floated 20 years, and rates are cranked up again.

Bollard acted to rein in the booming domestic economy and resultant inflation. He acknowledged it will cause pain among some exporters. It's all a rerun of the mid-1990s and the mid-1980s and is a fundamental flaw of the floating exchange rate - when the domestic economy overheats, as it undoubtedly has, the only way the RB can cool it is to hike interest rates, thereby damaging exporters as much, if not more, than the real culprit - the housing market and rampant consumer spending.

Already this week the timber industry revealed cracks in the system with Tanner Group announcing layoffs of 160 staff and largely blaming the exchange rate.

John Howie of Joknal Products, a Marlborough exporter of diabetic food called Dr Bollard's decision irresponsible.

He said he had given up quoting prices for his products in US dollars during the past six months as the kiwi dollar continued to gain in strength against it.

Bollard was complacent about the future outlook even with the prospect of another rate rise: "We forecast a soft landing out next year - we see it happening quite gradually. We don't see hard falls."

But other economists are not so sure. Westpac chief economist Brendan O'Donovan said reports of manufacturers shifting production overseas and plant closures are only going to grow from here, he said.

"We risk a hard landing. (Recession) is a possibility next year."

Deutche Bank chief economist Ulf Schoefisch doubts the rate move would greatly affect the domestic economy but would exacerbate the currency issue "and hit the wrong side of the economy - in other words exports".

Bollard seems to want a dollar each way on the currency. On the one hand he said the bank was aware it was at "very high levels" and assumes it will fall 15% in the next two years. On the other hand, he said it was justified at its current level by export commodity prices at 30-year highs.

"It's not out of line with the very strong commodity prices that we are enjoying at the moment," he said.

Dairy farmers may be insulated from the currency effects but those in tourism, forestry, fishing, or a host of other industries have seen hard won export markets and customers evaporate.

Bollard said the bank was not sanguine about the currency.

"We certainly realise that at these levels it is starting to hurt a number of firms in New Zealand especially those ones that might be stuck in US dollar exporting (that) can't have much room for natural hedging."

He said the bank had a picture of "a bit of hedging comfort still there" but he wouldn't quantify the bank's degree of concern about exports.

Some at the margin, who were tied in to US dollar pricing, would suffer.

O'Donovan says the RB underestimates the effects of currency's rise on the economy.

"I don't think they have got it right. I think they did have time to wait."

"They are really running the of stepping on the economy too hard. The economy is already slowing down."

He said we were only in the vanguard of the effects of the rising currency.

"The currency takes about a year and a half to hit the economy. We are just seeing the pressure in some manufacturing firms now."

O'Donovan estimated only half of last year's six rate rises had flowed through into the economy. This would happen as fixed rate mortgages were rolled over.

Bollard acknowledged the bank had to "confront the possibility that a further tightening in policy at this stage of the cycle might exacerbate an eventual slowing in activity.

"However, not responding to the prospect of stronger inflation pressures now would create a risk that inflation expectations and wage and price setting behaviour could change in a way that would make the task of containing inflation more difficult in the future, even if growth slows."

Bollard is grappling with inflation that is forecast to be stuck right at the top of the bank's 1-3% target for the next two years.

He pointed out there is a far greater risk of inflation breaking through the top end of the target than going below 1% should the economy suffer a hard landing.

Bollard wouldn't say whether his rate rise was a shot across the bow of the union movement which is pushing for a 5% across-the-board wage rise.

While the bank was not getting a picture of numbers running away, he said it was important people understood that inflation would not be allowed to get away and inflationary expectations were anchored.

"It doesn't matter who those people are," he warned.

"What's important to us is that we have those inflation expectations anchored."

Council of Trade Unions (CTU) economist Peter Conway said a higher wage rise was justified by productivity improvements and generally high profits.

Such wage increases did not need to affect inflation any significant extent, he added.

Certainly, there had been figures published recently that show workers have largely been left out of the economic boom of the 2000s. Workers have sacrificed wage increases for more jobs. If the jobs go, then Bollard's actions may have serious social and political consequences as well as economic.

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