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September OCR rise tipped as Bollard holds rates

The Reserve Bank is holding the official cash rate at 2.5 percent, as was widely predicted, but its governor Alan Bollard says the climbing dollar is dragging down the economy.

The Reserve Bank is holding the official cash rate at 2.5 percent, as was widely predicted, and its governor Alan Bollard says future rises may be unnecessary as the climbing dollar is dragging down the economy.

"The current very high value of the New Zealand dollar is acting as a drag on the New Zealand economy. If this persists, it is likely to reduce the need for further OCR increases in the short term," he says.

In March, the Reserve Bank cut rates to 2.5 from 3 percent. Since then it has held the OCR steady.

But Bollard says provided current global financial risks recede and the economy continues to recover, the bank sees little need for that "insurance" cut to remain in place much longer.

“The economy has grown more strongly than was expected, and it appears that the recovery is getting back on track, supported by a strong terms of trade.

"At the same time, however, current fragility in global financial markets, including the uncertainty around the US Government’s debt ceiling, continues to highlight the downside risk to trading partner activity."

The economy appears to be recovering more quickly than expected; GDP grew by 0.8 percent in the first financial quarter, while inflationary pressure is rising (albeit largely on the back of the GST increase).

A swathe of recent business confidence surveys also indicate growing optimism.

“Annual headline CPI inflation continues to be above the bank’s 1 to 3 percent target band," Bollard says.

"However, much of the current spike in inflation has been driven by the October 2010 increase in the rate of GST, and will therefore be temporary. Wage and price setters should focus on underlying inflation, which is currently estimated to be below 2.5 percent."

The next OCR review is due on September 15.

This week ASB economists predicted an OCR rise in December, but as speculation the RBNZ may raise rates in September grows, Nick Tuffley today said he now expects to see the OCR return to 3 percent sooner rather than later.

"Recent domestic developments have been encouraging, and the RBNZ is now more confident that the recovery is back on track. We now expect a 50 basis point OCR increase in the September meeting."

He says it's clear the RBNZ wants to reverse the March cut very soon. "That suggests a September hike is very likely, and the tone of the RBNZ’s language suggests a 50 basis point move is more probable than a 25 basis point increase."

However, this would be conditional on export commodity prices remaining firm and the global outlook "not disintegrating".

Westpac had also expected the RBNZ to act in December, but chief economist Dominick Stephens believes it will move earlier than that.

"The Reserve Bank's plan appears to be 50bp worth of hikes over the next couple of meetings, followed by a pause if the exchange rate remains high."

Tuffley says the OCR is likely to reach a high of 4.5 percent.

"Beyond this first move, we see the RBNZ pausing until January, then resuming steady 25 basis point OCR increases to a peak of 4.5 percent."

BNZ's chief economist Tony Alexander is predicting a slightly higher OCR peak of 5 percent next year, although he says global conditions and the high dollar have stayed the RBNZ's hand for now.

"The markets have now moved to factoring in a 0.5 percent cash rate rise from September and that is our view also now. We then expect no rise in October then another in December so the cash rate ends the year at 3.25 percent.

"We then see another rise as likely in March and the rate ending 2012 at 5 percent."

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