Roger J Kerr tells Graeme Wheeler to take the slow boat to the normalisation of our short-term interest rates

 By Roger J Kerr

Over the next few weeks in the lead-up to the RBNZ’s Monetary Policy Statement on 13 March the interest rate markets and economic commentators will be debating whether there is any justification for Governor Wheeler to increase the OCR at a faster or slower rate than what the markets are currently pricing.

The market is pricing a 110 point increase over the balance of 2014 and then another 75 points next year, leaving 90-day market interest rates above 4.50% in late 2015.

The arguments for tightening monetary policy at a faster rate centre around inflation already rising rapidly due to strong economic growth and price pressures in the construction industry due to shortages of resources.

The great danger of lifting interest rates too high, too soon is that the NZ dollar soars higher and export industries get thumped.

The arguments for taking it cautiously at a slower rate is based on striking the delicate balance between controlling inflation, however not damaging the productive sectors of the economy in doing so.

While the NZD/USD rate remains firmly above 0.8000 and the TWI above 77.00, Governor Wheeler will be reluctant to increase interest rates at a more rapid pace than what the market is currently pricing and the RBNZ assuming.

In the high currency scenario, very low tradable inflation (imported items) will keep overall inflation well below 3%.

What will be frustrating the Governor is the delay in the US dollar strengthening against all currencies in global forex markets.

A stronger USD would pull the NZD/USD rate below 0.8000 and provide the window for the RBNZ to raise interest rates without damaging the exporters.

What will be satisfying to the RBNZ at this stage is the fact the LVR home mortgage lending regulations on the banks introduced last October appear to be having the desired impact i.e. slowing activity levels down in the speculative end of the residential property market.

Rising mortgage interest rates and progressively more housing supply this year will also level the housing market off and reduce inflation threats.

While the RBNZ will be lifting their GDP growth forecasts for this year on 13 March, they will also highlight the risks to the economy achieving such strong growth e.g. wholemilk powder prices reducing sharply, a weaker Australian economy and the potential for a credit related fall-out in China.

Rock star economies can also falter on factors beyond their control.

Overall, I see a higher probability of NZ Inc under-performing the hyped-up forecasts for 2014 than out-performing.

Today’s retail sales numbers for the December quarter being below expectations may be the start of some more sobering results.

For these reasons Governor Wheeler is better advised to take the slow boat to the normalisation of our short-term interest rates.  

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Roger J Kerr is a partner at PwC. 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