By Roger J Kerr
Who would want to be in Alan Bollard’s shoes right now? Damned if he does and damned if he doesn’t.
As many others have stated over the last three years, implementing the emergency monetary stimulus in 2009 was the easy part (dropping the OCR to 2.50%), unwinding the stimulus was always going to be the hard part.
Based on GDP growth and inflation starting points today being substantially above all RBNZ expectations, he really should be shoving interest rates up now.
The inflation risks and inflation expectations are elevated sufficiently over the next 12-18 months to justify a monetary policy setting on the slightly tighter side of neutral, not extremely loose as they currently stand.
However, Alan cannot raise official interest rates immediately as it will only shunt the Kiwi dollar even higher than its current 30-year highs of 0.8500. Yet again, he is between a rock and a hard place with monetary policy management.
He could argue that the FX markets have already fully priced-in significant interest rate increases and thus if he did lift rates the Kiwi would not necessarily go any higher. That is a pretty bold assumption and not one Alan would want to risk at this point of time. The RBNZ have been heavily criticised in the past for damaging the export/productive sector too much to combat inflation that is supply-side sourced rather than demand related. He will be reluctant to go there.
So, the RBNZ have a real dilemma here, interest rates are too low for an economy growing reasonably well and for an Auckland housing market starting to reflect a shortage of new houses being built in recent years and a shortage of existing housing stock being made available for sale.
It seems the RBNZ will wait for the June quarter’s GDP figures, due out in late September, before being convinced about the sustainability of the stronger economic growth. Therefore, the first increase could well be the 27 October OCR review date. It is too late off course; however he will be hoping that USD strength and global commodity price weakness between now and then will take the heat out of the NZD/USD exchange rate and bring it down. An increase in interest rates when the Kiwi dollar is at 0.7500, rather than 0.8500, should be more palatable for the export economy.
The high currency value at 0.8500 offers other challenges to the RBNZ. Most economists will now be forecasting annual inflation to be above 3.00% in 12 months time, not at a comfortable 2.00% mid-point the RBNZ have been forecasting.
However, how much will the high Kiwi dollar bring down the prices of imported consumer items?
Likewise, how much should +4.50% GDP growth forecasts for 2012 be lowered to cater for USD exporters being non competitiveness above 0.8000?
Tricky questions that I am sure are occupying the minds of RBNZ economists right now.
These will not be the RBNZ’s only worries at this time. If they were not suspicious as to the reliability of their model for the NZ economy before the GDP shocker, they will be seriously worried after it.
The +0.8% GDP growth was not due to any one-off factors - it was almost across all industry sectors. Forestry and construction were the exceptions; however construction will certainly be expanding from here with the Christchurch re-build.
Similar to the 1993 and 2003 recoveries out of recession for the NZ economy, the RBNZ on both those previous occasions under-estimated the speed and strength of the export-led growth and left tightening of policy too late. It may be argued that the circumstances are different today, however not dramatically different.
As has been stated many times in this column over the past 12 months, if you watch the retail/housing indicators as a lead for economic growth, you are watching the wrong things.
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* Roger J Kerr runs Asia Pacific Risk Management. He specialises in fixed interest securities and is a commentator on economics and markets. This column was written before the Monday quake. More commentary and useful information on fixed interest investing can be found at rogeradvice.com
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