Interest rate raised to 5%

By Phil Boeyen, ShareChat Business News Editor

Wednesday 20th March 2002

The Reserve Bank has moved quickly to put the brakes on the strong local economy by increasing the official cash rate 25 points to 5%.

In its Monetary Policy Statement early Wednesday Reserve Bank governor Don Brash claimed that New Zealand's economy is operating at close to full capacity, and indications are that pressures will grow further in the absence of some increase in interest rates.

"In the last few months of 2001, the OCR was reduced by 100 basis points because we were concerned about the deflationary risks arising from a very weak world economy.

"Since our last statement, the New Zealand economy has been stronger than we expected. Both consumer and business confidence have bounced back to pre-11 September levels.

"After a brief pause in October, retail spending has been strong. Visitor arrivals have recovered quickly. Turnover in the housing market has been high, and residential investment has surged. In recent months there has been a sharp turnaround in net migration."

Dr Brash says the risks to the global economy also look less threatening with economic activity in the United States picking up more quickly than most observers expected late last year, and the Australian economy looking robust.

"Nevertheless, the global economy is still not particularly strong. It seems likely that on average our trading partners will grow only moderately this year, and significant risks remain.

"The Japanese economy continues to have major difficulties, the US recovery could stumble over the high level of debt already accumulated, and global equity markets remain vulnerable to further weakness."

The bank says that even after today's decision to raise interest rates, monetary conditions remain stimulatory.

"Today's increase in the OCR simply represents some withdrawal of monetary stimulus, much of which was put in place as insurance against risks which have now receded," Dr Brash says.

Looking forward the bank says it is likely that there will be a need for higher interest rates if inflationary pressures are to be contained.

"Headline inflation has been at or above the top of our inflation target for much of the last 18 months, and for a number of reasons that seems likely to continue to be true for most of this year."

Dr Brash admits that some of the causes of the relatively high inflation relate to matters to which monetary policy should not react, such as the increased tax on petrol and the weather-related increase in the price of fruit and vegetables.

However he says there is a risk that this prolonged period of inflation near the top of the inflation target may lead people to adjust their inflation expectations upwards, making the task of controlling future inflation more difficult.

"At the moment it seems likely that there will need to be some further reduction in monetary stimulus over the months ahead," the Reserve Bank governor warned.

The lift in interest rates will have come as some surprise to the market, with most commentators predicting rates would not be increased until May.

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