By Roger J Kerr

Market swap interest rates have rallied lower over recent weeks, reflecting the belated re-assessment by the markets about the timing of OCR increases in 2010 from the RBNZ.

Swap yields may struggle to move a great deal lower from here, but do not expect any lift up for several months either.

The market outlook therefore appears very stable over coming months. Therefore, we have some time available to think about wider relationships between economic growth, inflation and short-term interest rates.

These two charts below support the view that 90-day interest rates may not travel much above 5.00% over coming years:-

The new 5.00% paradigm level is being established on the proviso that annual inflation stays around 2.00% and that annual non-inflationary GDP growth (Output Gap) sits about +3.00%.

The 5.00% benchmark also being maintained on the pre-condition that the RBNZ's new "core funding ratio" regulatory control of the banks is effective and bank lending margins remain at elevated levels.

In addition to having more tools in their kit-bag, the RBNZ also needs to think about how it can use its influence and power to create economic policies that deliver more competition in the economy.

Competition is the best weapon against inflation, thus the RBNZ should have more powers to push for more competition in the economy so that inflation is cut off at the real source.

We need workable competition policies that reduce the risk of upwards price pressures at the outset, rather than having the ambulance at the bottom of the cliff (RBNZ monetary tightening) to rein inflation back in once it is already out of the bag.

If you have nothing better to do, have a look through the quarterly RBNZ monetary policy statements since they started in the early 1990's and observe how many times they mention the word "competition".

Not many.

Former Governor Dr Don Brash use to talk about competition in the economy, however the current Governor seems to think it is either an unimportant aspect of controlling inflation or just outside the domain of his contract with the Finance Minister.

Either way, if the RBNZ is truly responsible for inflation control, addressing the real sources (lack of competition over price-setting behaviour) would be a good place to start.

"”"”"”"”"”-

* Roger J Kerr runs Asia Pacific Risk Management. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com