The Reserve Bank should avoid further damaging the economic recovery by making "another premature" Official Cash Rate (OCR) hike next Thursday, the New Zealand Manufacturers and Exporters Association (NZMEA) says.
The central bank lifted the OCR by 25 basis points to 2.75% on June 10, its first hike since July 2007. ASB economist Jane Turner expects the Reserve Bank to hike the OCR by another 25 basis points on July 29 lifting it to 3%, with the accompanying statement retaining a similar tone to June's.
"Weighing up the export-led economic recovery and growing inflation concerns against the risks remaining around the global outlook, the Reserve Bank is likely to keep an element of caution, sticking with the line that future hikes remain dependent on economic and financial market developments.”
Turner suggests the Reserve Bank may have made slight downward revisions to growth, given weaker than expected GDP, recent fall in dairy prices and rapid slowing in net migration. That said, she says the outlook for an export-led recovery remains in place.
"However, the slightly softer growth outlook does not allow for comfort on the inflation front. Headline inflation is still set to peak well over 5% due to a raft of Government related price spikes, and in our assessment the Reserve Bank was slightly underestimating medium-term inflation pressures in its last forecasts."
Hike 'not warranted'
In contrast NZMEA chief executive John Walley argues below forecast cost price inflation (CPI) and lower than expected economic growth simply don't warrant another interest rate rise yet.
"The Reserve Bank based last month’s decision on a reading of economic conditions that has been shown to be optimistic," Walley says.
"Demand, commodity prices and employment point to, at best, a weak and unbalanced recovery."
"Currency and commodity price volatility, lower growth than expected, weak house sales and supermarket spending slipping for the first time ever in May; all these factors point to an unstable recovery."
None of these indicators highlight an inflation problem, Walley maintains.
"A dip back into recession in Europe or stagnation in China could see commodity prices fall further and very quickly. The risks posed today by these potential shocks far outweigh any potential inflationary pressures a year or so down the track.”
Furthermore he says the latest CPI statistics show non-tradeable inflation is driving the CPI numbers while tradeable inflation was negative. Increasing the OCR has little impact on non-tradeable inflation so is unlikely to fix the problem.
“Further efforts by the Reserve Bank on prudential supervision to restrict banks access to offshore funds, rather than another damaging cycle of rate hikes and currency appreciation, would better target domestic inflation pressures.”
Additionally upwards pressure on the New Zealand dollar since June's OCR hike damages economic recovery and any economic rebalancing.
“We have said for some time that September should have been the earliest point to consider any moves on the OCR. At this point even September seems too early," adds Walley.
'No comfort on inflation'
Turner, however, says the slightly softer growth outlook doesn't allow for comfort on the inflation front. The Reserve Bank is tasked with keeping inflation between 1% and 3% on average over the medium term.
The "raft of Government related price spikes" Turner refers to include GST being increased to 15% from 12.5% on October 1, higher energy costs since July 1 following the introduction of the Emissions Trading Scheme, higher than usual increase in ACC levies and increased tobacco excise taxes.
"There remains a clear risk that inflation expectations will become unanchored further down the track," says Turner.
"We expect the Reserve Bank will continue to withdraw monetary stimulus by steadily increasing the OCR in 25 basis point steps at each meeting until the OCR reaches 5%," says Turner.
She notes, however, that market pricing is more gradual than this, reflecting ongoing "event risk" posed by Europe’s sovereign debt difficulties.
She does acknowledge that the overall flow of recent economic data has been on the softer side of the June Monetary Policy Statement forecasts. The Reserve Bank may therefore be facing some downward revisions to its growth outlook.
"(But) In contrast to the Reserve Bank, the recent flow of data has been less of a surprise to us. The Reserve Banks forecasts have been above the consensus average for some time, and any downward revisions would largely reflect the Reserve Bank moving closer to the consensus view."