Alan Bollard is not going soft on inflation

By Roger J Kerr

Last week’s OCR review statement from the RBNZ has been criticised in some quarters for being too “wimpish” in not more forcefully addressing the inflation risks from a stronger growing economy i.e. pushing interest rates up by more and earlier than what the statement implied.

That criticism is unwarranted in my view.

The RBNZ know all too well the massive influence the exchange rate level has on overall performance of the NZ economy. A NZD/USD exchange rate in the 0.8000’s, let alone the 0.8800 level it sits at currently, is incredibly damaging to future export returns and profitability, therefore business expansion/investment plans are shelved.

Current GDP growth forecasts of 4.50% for 2012 have to be revised seriously downwards in this exchange rate environment and with that future inflation risks decrease. Mainstream economic forecasters in criticising the RBNZ for not being hawkish enough at this point are only demonstrating their own lack of understanding of what drives the NZ economy.

The stronger growth in the economy from September last year through to March was well above what most forecasters/commentators (not this one!) believed to be happening, because they did not recognise the expansion that took place in the big export industries that dominate economic growth. Now they are failing to recognise the damaging impact the high currency will have on those same export industries and thus GDP growth next year.

The RBNZ are right to be circumspect and cautions around the negative currency impact on the economy. Off course, the high Kiwi also lowers prices of imported consumer goods and reduces inflationary pressures.
Therefore, the market interest rate outlook has to be a 0.50% OCR increase in September to remove the March earthquake insurance cut, thereafter a track of further increases that will be highly exchange rate dependent.

If the NZD/USD rate is still above 0.8000 come October/November, Alan Bollard will be justified in holding back on further increases. The high exchange rate tightens monetary conditions in the economy enough without adding large interest rate increases on top. Ignoring the exchange rate impact on monetary conditions would be imprudent monetary policy management.

A slower rate of increase for short-term interest rates does not mean that longer-term rates (determined by US bond yields) cannot increase over the next six months. More US Government debt just means more Treasury Bonds to sell i.e. market yields higher. There has been a flight to quality of buying US Treasury Bonds through the US debt crisis forcing 10-year yields down to 2.80%, once that resolves itself I would expect the yields to climb back up again to 3.00% and higher

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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