By Roger J Kerr
Borrowers and investors wondering about the track of 90-day wholesale interest rates over the next 12 months would be well advised not to listen to either media commentators or bank economists.
Too many media types have a misplaced view that the Reserve Bank should not be “tightening” monetary policy as the economy is too weak right now.
Firstly, the RBNZ is not tightening monetary policy at all, as Governor Bollard has stated on numerous occasions he is just removing the emergency loose monetary policy settings he put in place when the world economy almost stopped 15 months ago.
At that time the RBNZ slashed the OCR from 5.0% to 2.5%. The increases from 2.5% back to 5.0% over the next 9-12 months are merely the withdrawing of that special stimulus for that special occasion.
So this is not a tightening of policy, merely a simple and staged return of monetary policy to neutral at 5.0%.
The RBNZ is totally justified in taking this mechanical and stepped approach with both GDP growth and inflation forecast to be higher in 12 to 18 months time. They are not setting monetary policy for today’s economic conditions; they are being set for the forecast conditions in 12 months time.
Several bank economists are boldly forecasting that the RBNZ will increase the OCR to 3.50% by Christmas and then “pause” to see the impact of that increase in interest rates.
They too completely misunderstand, or choose to challenge, the clearly signalled RBNZ intention to take monetary settings back to neutral. The local and global economic outlook would have to change dramatically over coming months to justify a “pause” at Christmas.
I see the probability of a pause as very low; the far more likely scenario is 0.25% increases in the OCR at every review date and MPS date until we get back to 5.00%.
Such an increase will not have a detrimental impact on our economic recovery.
The recovery is coming from the export sector and only an unexpected strengthening in the Kiwi dollar will upset that growth.
I do not see these increases in short-term interest rates having mush of an impact on the domestic economy either. Variable rate home mortgage lending rates may move from the current 6.00% levels to 7.25% (+1.25%) over the next 12 months, whereas 90-day wholesale interest rates will move up by 2.00% from 3.00% to 5.00%.
The banks are already paying 5.00% for their domestic retail deposits and longer term offshore wholesale funds, so there is not much change or impact on the bank’s cost of funds from the OCR or 90-day wholesale rates increasing.
The RBNZ of course know all this, and that is why they are correct to ignore the media commentators and bank economists about when and how short-term interest rates increase.
The recent weaker local economic data in terms of retail sales, consumer confidence, immigration, housing activity and inflation are not sufficient to change the RBNZ’s medium term economic outlook.
In five or six months time Governor Bollard will be forecasting 4.00% GDP growth for 2011 and the annual headline inflation rate will be at 5.00%.
He cannot afford to be complacent or listen to the naysayers.
* 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