Hawkish Reserve Bank raises rates

Thursday 10th June 2004

Reserve Bank governor Alan Bollard has raised interest rates, as expected, citing the economy's strong growth over an extended period, and flagged that further rate hikes are likely.

The central bank has been expecting growth to slow due to factors such as the high New Zealand dollar and declining population growth.

"But activity has continued to prove stronger than expected, and stretched productive resources have caused inflation pressures to increase across a range of industries," Bollard said on announcing his decision to raise the official cash rate (OCR) from 5.5% to 5.75%.

The decision was unanimously anticipated by economists, a contrast to the central banks' previous decisions this year which have been viewed as finely balanced.

In the wholesale interest rate market following the announcement, the 90-day bank bills, from which floating mortgage rates are priced, rose from 5.99% to 6.04%.

The Reserve Bank is also signalling that the OCR could rise as high as 6.25% before the end of this year.

"What's interesting is that they seem to be very hawkish and focused on the potential upside risks to inflation further out," says Nick Tuffley, an economist at Westpac Bank.

The central bank is projecting that the inflation rate will temporarily breach the upper side of its zero to 3% target in 2005. While it wouldn't be appropriate to hike rates just to head off this possibility, given that inflation is expected to fall again, "we will need to remain alert to signs of more enduring effects that could arise if wage or price setting behaviour starts to change," Bollard said.

Craig Ebert, an economist at Bank of New Zealand, agrees the statement is probably more hawkish than the market expected. "If there are any risks to the target, they're very much on the up side," he says.

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