Bollard raises rates, leaves the door open for more

By Jenny Ruth

Thursday 10th March 2005

Reserve Bank governor Alan Bollard has chosen the hawkish option, raising interest rates again and not ruling out the possibility of further hikes while emphasising that inflation pressures are stronger than expected.

Bollard raised the official cash rate (OCR) to 6.75% from 6.5%, his seventh hike since the beginning of 2004 when the OCR was at 5%.

The move had a dramatic impact on the New Zealand dollar, pushing it up from 73.55 US cents before the rise was announced to 74.10 US cents. In wholesale interest rate markets, one-year forward rate agreements, from which mortgage rates are set, jumped from 6.97% to 7.09%. However, two-year agreements rose only slightly from 6.94% to 6.96%. The most intense competition in the mortgage market is in two-year fixed rate loans.

Craig Ebert, an economist at Bank of New Zealand, which had been predicting a rate rise, says today's monetary policy statement is "a sensibly written document."

"It wasn't by any means a done deal, but there's a bigger risk of inflation becoming too high if the hadn't tightened," Ebert says.

"If it turns out they've tightened 25 points too much, there will be a little bit more of a slowdown. To our way of thinking, the risks were certainly on the side of inflation being higher."

Those inflation pressures are likely to linger. "That accounts for the tightening bias for a little while yet." Ebert rates the chances of another rate hike in either April or June at about 50/50.

Ulf Schoefisch, an economist at Deutsche Bank, which hadn't thought a rate rise today was necessary, says Bollard had a lot of factors to weigh up in reaching his decision.

He rates the chance of another rate rise at about a third. "To be fair to Bollard, he's not beating the drum too hard on that, he's just left it open."

However, the economy is slowing and "the bank's just driven another nail into the economy."

Bollard notes that housing activity is continuing to ease, although it has been held up at least temporarily by last year's mortgage price war. "The pipeline effects from last year's policy tightening will continue to raise
average effective mortgage rates through this year but the impact will be gradual," he says.

The statement says underlying house sales activity has been stronger than the central bank had expected. "Feedback from lending institutions suggests that borrowing for housing purposes remains robust." House prices are still rising in many parts of the country, it says.

While house price inflation has slowed from its 24.8% peak at the end of 2003, it still remains high. And although the cost of building new houses has risen, it hasn't risen as much, supporting the high level of residential investment over the past two years, the statement says.

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