BNZ economists say a 50-basis-points rise in official interest rates is fully justified by the current growth in the economy

BNZ economists say the Reserve Bank should be hiking interest rates this week - and by 50 basis points, judging by how strongly the economy is growing.

And the BNZ has brought forward again the timing of when it expects the RBNZ actually will make its first upward move.

Head of research for BNZ Stephen Toplis conceded in the bank's weekly "Market Outlook" that the chances of the RBNZ moving rates when it makes its next official call on Thursday were "nigh on zero". The universal market view is that there will be no change to the Official Cash Rate, which has now been sat on 2.5% since March 2011.

Toplis concluded that the central bank would not raise rates this week "because that’s what they’ve been telling us for some time now".

But he said it did not make sense that the OCR was currently at record lows and real mortgage interest rates were both negative and falling.

"In our opinion, the Reserve Bank should be hiking its cash rate this week, and probably by 50 basis points, in order to ensure that domestic demand does not get out of control," Toplis said.

• building sector activity is rising aggressively;
• the agriculture sector is faring well on the back of rising commodity prices and a bounce-back in production post-drought;
• commodity price gains have been reflected in a terms of trade which has risen to its highest level since 1973;
• retail sales growth is robust;
• employment intentions are very strong;
• services are performing well;
• tourism numbers are rising steadily driven by growth from China;
• net migration inflows are adding significantly to population growth and, in turn, domestic demand.

Toplis said there was very little doubt GDP growth would accelerate to an "above trend" level in the very near future.

"We have annual growth peaking at 4% in [the second quarter of] next year but the balance of risk is that it will push even higher."

Above trend growth meant that any spare capacity in the economy would be absorbed.

Unemployment to drop quickly

This would be highlighted by the unemployment rate dropping quickly to around 5%.

"Such absorption will result in non-tradables inflation pushing higher. Conceivably, this will be occurring at a time when the disinflationary pulse from an appreciating currency begins to dissipate resulting in heightened tradables inflation as well. Put the two together and annual CPI inflation will start testing the top end of the Reserve Bank’s target band by early 2015," Toplis said.

He said that BNZ economists would be following this week's statement from the RBNZ "with more fascination than usual".

"...We are dying to see how the Reserve Bank reconciles the aforementioned issues with its past-stated intent to hold off tightening until around June next year.

"If the Reserve Bank was entirely consistent with its previous commentary it would have to confirm that the tightening cycle will not commence until June at the earliest. This conclusion originates from the September Monetary Policy Statement."

'The most disconcerting thing'

Toplis said that perhaps the most disconcerting thing for the RBNZ was that mortgage interest rates for sub-80% LVR borrowers were falling.

"It will be particularly worrisome for the [central] bank that floating rates, which the majority of borrowers face, are in decline because this means that not only are marginal rates falling but so too rates on the existing stock of lending. On balance, this means that monetary conditions are easing aggressively for many.

"If the Reserve Bank is to surprise with an earlier tightening, this will be the catalyst.

"Be that as it may, from a purely consistency perspective, it will require some very good story telling if the RBNZ is to formally suggest an early-year tightening. Indeed, the story telling would have to be excellent to bring the tightening forward from June!"

Toplis said that with this in mind, it seemed highly unlikely the RBNZ would point to, or follow through with, a January rate hike.

"We thus think current market pricing for a 35% chance of an increase is overdone."