By Roger J Kerr The management of monetary policy (and thus interest rates) is under real scrutiny again as the RBNZ find themselves in a real bind between (yet again!) the rock and a hard place. Monetary conditions have involuntary tightened over the last few weeks as both the currency and term interest rates have increased. That tightening is partly a result of the early March Monetary Policy Statement from the RBNZ that included a +4% GDP forecast for 2010 and a comment that "our capital markets must remain internationally competitive" - translation: our interest rates cannot go too far below Australia's. Add in a recovery in Wall Street, stabilising commodity prices and perhaps the global economic recession "armageddon" not sending New Zealand into sack-cloths as many were painting a picture about, and perhaps the increases are not too surprising. What does Dr Bollard do now?

The "open mouth operation" verbal intervention attempted last week had an impact for five minutes and has been ignored since. To maintain credibility the Governor now really has to follow-up the verbal threats with affirmative action. The next OCR review date is April 30 and a 0.25% or 0.50% cut from 3.00% must be a certainty if the currency and interest rates remain where they are right now. Neither the economy nor the RBNZ want a plunging currency, but we also do not need a pre-mature appreciation of the NZ dollar this year derailing the export-led economic recovery. As always, the RBNZ tread a fine line between over-stimulating the economy (and thus higher inflation later on) with interest rates being too low and the opposite risk of holding back a much needed economic recovery. On balance, I would think that the RBNZ will not see too much risk in cutting by 0.50% with the Kiwi at 0.5900. It may have been a different decision of the Kiwi was pushing 0.4500 today as all the bank economists were predicting. Even if the RBNZ cut by 0.50% to 2.50% on April 30, my view is that the 3 years plus swap interest rates will not fall too much at all. The end result come May will be an even steeper upward sloping yield curve from 2.50% for overnight money to near 6.00% for 10-year money. The steep slope continues to send a message that the vast majority of borrowers and investors expect short-term interest rates to be considerably higher in 12 and 24 months time. In this respect it may not make a great deal of difference to the end-game if the RBNZ keep the OCR at 3.00% or reduce it to a final bottom of 2.50%. The market forces will prevail as the combined decisions of both investors and borrowers determine the interest rate levels. If wholesale or retail investors will not invest at 4.00% fixed for two or three years, it tells you a lot about future expectations for the economy, inflation and interest rates. What the yield curve is telling me is that the negative impact of the global recession on the NZ economy is no-where near as bad as the pundits were anticipating. Having said that, the three to 10 year swap rates will travel across the page over coming months until consumer and business confidence improve and there is more hard evidence of an export-led recovery. When that happens, it will already be too late for borrowers to fix. ---------------- * 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