Reserve Bank raises rates and signals more to come

By Jenny Ruth

Thursday 9th September 2004

As expected, Reserve Bank governor Alan Bollard has raised interest rates for the fifth time this year and is promising more to come is likely.

He raise the official cash rate (OCR) from 6% to 6.25%, citing the surprising strength of the economy, stretched resources and strong inflation pressures.

Nobody was surprised at the move itself, least of all Bank of New Zealand economists who were already predicting another rate rise in October and a 40% chance of yet another move in December.

BNZ economist Stephen Toplis says his bank will probably move to a formal prediction of a December rate increase after today's statement. That would take the OCR to 6.75% which he says "won't be too far from the top."

The Reserve Bank has "clearly signalled that the economy's operating at above full capacity and that growth needs to slow a lot to relieve those tensions," Toplis says.

"Even at these levels, interest rates are only barely above what's commonly considered to be neutral. The big problem with the tightrope they're (the Reserve Bank) are walking is that they need to slow the economy substantially but they don't want to throw it into recession," he says.

But Brendan O'Donovan, chief economist at Westpac Bank, thinks Bollard is risking just that. While he too thinks a further rise in the OCR in October is "virtually guaranteed" by today's statement, and that the OCR is likely to hit 6.75% by year's end, he thinks Bollard should be allowing time for the rate rises to date to start working. It is generally assumed that a rate increase takes between a year and 18 months to start affecting activity.

"At the moment we've still got the big tail wind from last year's big house price increases" and that should last through to the first quarter of next year.

O'Donovan says that with about two-thirds of bank lending now at fixed interest rates, it takes about 1.4 years on average before individuals re-fix their loans.

He also compares the New Zealand central bank's actions to that of Australia's Reserve Bank. While the RBNZ has raised the OCR from 5% to 6.25% so far this year, the RBA has raised its cash rate from 4.75% to 5.25% only.

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