More rate rises not urgent and may be unnecessary - Carr

By NZPA

Wednesday 14th August 2002

Acting Reserve Bank governor Rod Carr today left the Official Cash Rate (OCR) unchanged and said further interest rate rises were not urgent and may be unnecessary.

Dr Carr made his decision despite projecting the economy to be growing beyond its sustainable rate and predicting faster growth next year.

As well, core inflation was estimated to be running at the top of the bank's 0-3 percent target.

The choice to hold the cash rate, which had been raised on each of the last four OCR reviews, was down to the influence of a wobbly world economy.

"We are now in receipt of one of the more serious of the storm warnings issued since the late 1990s when the Asian financial crisis combined with two drought seasons," Dr Carr said in his August Monetary Policy Statement.

The news appeared good for borrowers. Replacing its May prediction that 90-day bank bills will rise to 7 percent next year, the bank now forecasts bank bills, from which retail banks mainly fund home lending, peaking at 6.25 percent in the first half of next year and falling back to 6 percent by the second half of 2003.

"In May it looked likely that further increases in interest rates would be required over the coming year to keep inflation within the target band, but that prospect now looks less likely," Dr Carr said.

While not ruling out further rises, he hinted the current tightening cycle is nearly exhausted.

"We are not treating the potential need for a further rise in interest rates as urgent, or at all certain."

According to the bank's projections of the 90-day bill rate, borrowers can expect near stable rates for the next 18 months.

In the money market, bank bill yields fell three basis points to 5.87 percent while December bill futures rallied 18 points to an implied interest rate of 5.84 percent.

The Reserve Bank's decision came hours after the United States Federal Reserve decided to leave the Fed Funds rate unchanged at 1.75 percent. It signalled the next move may be an easing as the US economy teetered towards further weakness.

Commentators have mixed views on where rates will go from here. Stephen Hong of BNZ Investment Management believes the economy will turn down.

"We see rate decreases from these levels next year."

But Westpac economist Paul Conway forecast the next rate move will still be up. "We think there's more increases in the cash rate down the track."

Deutsche Bank chief economist Ulf Schoefisch noted the central projections still called for further rate hikes but "they qualify that a lot".

He believes the peak might have been reached because of the weakening global situation and signs of softness in the domestic economy.

Dr Carr said the prospects for the international economy had become "increasingly clouded, with sharp falls in equity markets and heightened investor nervousness in the US and elsewhere".

"Although the New Zealand economy has performed well over the past year, the odds of an international slowdown have increased, which would have adverse consequences for the performance of the New Zealand economy."

It was a tough task to gauge how inflation would be affected by global developments, he said.

The bank forecasts consumer price inflation will stay around 2.5 percent this year and next and then drop to 1.75 percent in 2004 and 2005. But it estimated that core inflation, excluding one-off influences, was running higher than CPI inflation, close to 3.0 percent.

Domestic prices had risen across a broad front and this was almost certainly related to the economy growing faster than the estimated sustainable growth rate over the last three years, Dr Carr said.

Plausibly, the effect of the global wobbles would remove upward pressure on inflation.

"But conversely, the economy may continue to grow at a pace that maintains pressure on resources," he said.

The bank forecasts the economic growth rate would increase from 3.2 percent in 2002 to 3.5 percent in 2003 before easing. In May, the bank was forecasting growth next year would be just 2.75 percent. It is still forecasting 2.5 percent growth for 2004.

Export volumes are projected to rise marginally but earnings will fall due to weaker prices. And the slowdown in the external sector would channel through to the domestic sector slowing the recent "frenetic pace".

On balance, current global developments, recent falls in export prices, a higher exchange rate and the lagged effects of the four previous rate rises were likely to dampen inflation pressures.

Of all the threatening economic developments, the current capital market dislocation had the potential to be the most serious, Dr Carr said.

As well, despite the rosy outlook for the domestic economy, a number of indicators suggested the momentum in the economy was slowing.

"For now, the prudent response is to pause, and to watch and wait," he said.

The dovish tone of the statement cause the New Zealand dollar to fall nearly half a US cent to US45.58c.

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