Rate rise surprises, mortgage rates to rise

Contrary to most economists’ expectations, Reserve Bank governor Don Brash raised his official cash rate (OCR) from 4.75% to 5%, citing a stronger than expected New Zealand economy and a less threatening global economy.

Wednesday, March 20th 2002, 10:31AM

by Jenny Ruth

Contrary to most economists’ expectations, Reserve Bank governor Don Brash raised his official cash rate (OCR) from 4.75% to 5%, citing a stronger than expected New Zealand economy and a less threatening global economy.

All but one economist was picking no change in rates today. However, the move came as little surprise to the wholesale interest rate markets which had been pricing in a rate rise for some time.

Nevertheless, the hawkish rhetoric in Brash’s statement pushed wholesale interest rates higher and mortgage rates are sure to follow soon. Brash signalled further rate increases are likely in coming months.

The 90-day bank bill’s moved up about 10 basis points to 5.9% immediately after the announcement, which implies Brash will raise rates another 50 basis points by May and with more tightening to come.

The two-year government bonds jumped from 6.08% to 5.2% while the three-year bonds rose from 6.46% to 6.54%.

"There’s been considerable debate within the financial markets as to whether traders’ pricing or economists’ words were going to be more correct. Brash has sided with the traders," says Peter Cavanaugh, associate director at Bancorp Treasury Services.

Nevertheless, Brash says even with today’s rise, monetary conditions are still stimulatory to the economy. "Today’s increase in the OCR simply represents some withdrawal of monetary stimulus, much of which was put in place as insurance against risks which have now receded," Brash says.

In the last few months of 2001, Brash cut the OCR by a percentage point because of the deflationary risks from the then very weak world economy.

"Since our last statement, the New Zealand economy has been stronger than we expected. Indeed, the economy is already operating at close to full capacity and indications are that pressures will grow further in the absence of some increase in interest rates," Brash says.

Both consumer and business confidence are back to pre-11 September levels, retail spending has been strong after a brief pause in October, visitor arrivals have recovered strongly and net migration has turned sharply positive, he says.

As expected, he is also focusing on the housing market. "Turnover in the housing market has been high and residential investment has surged."

Brash also notes the US economy has picked up faster than expected and the Australian economy "looks robust."

Mark Brown, fixed interest manager at Alliance Capital Management, says the indications in today’s statement are that "they’re going to do more faster than people had thought. If you read the text, it all suggests they want to get to slightly tighter than neutral and there’s a fair amount of movement needed to get there," he says.

There’s a fair amount of debate as to where a neutral OCR, one which neither stimulates nor impedes economic activity, would be, but most see it somewhere between 5.5% and 6%, which on traditional bank pricing would imply floating mortgage rates between 7.25% and 7.75%. The five major banks’ floating rates are currently 6.7%.

ASB Bank economist Anthony Byett, the one economist who correctly picked today’s move, says because the 90-day bank bills, from which the banks typically fund their floating rate mortgages, have already risen, banks’ profit margins have been squeezed in recent weeks.

Brash still held out some hope rates may not go that high. "The global economy is still not particularly strong. It seems likely that on average our trading partners will grow only moderately this year and significant risks remain," he says.

The Japanese economy is still in major trouble, the US economy "could stumble over the high level of debt already accumulated and global equity markets remain vulnerable to further weakness," Brash says.

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