Domestic inflation concerns prompt another rate increase

In a decision regarded by all economists as very finely balanced, Reserve Bank governor Alan Bollard opted to raise the official cash rate (OCR) from 5.25% to 5.5%, citing strong domestic inflation pressures.

Thursday, April 29th 2004, 10:35AM

The New Zealand economy continues to perform strongly, supported by an improving global economy. While some data suggest the economy may be cooling, the evidence is mixed, Bollard says.

Reflecting how close the decision was, market pricing suggested a better than 50% chance of a rate rise and after the announcement the 90-day bank bill yield rose from 5.65% to 5.75%.

While the widespread view is that the recent fall in the currency was the major catalyst for today’s rate rise, Bollard doesn’t mention that until the fifth sentence of today’s brief statement.

"At this stage, it remains unclear whether the fall in the exchange rate over recent weeks will be sustained and thus what its impact on activity and inflation pressures will be," Bollard says.

The New Zealand dollar has fallen from near 71 US cents in February to just over 62 cents now.

"Reading between the lines, it looks like the drop in the currency was the main driver," says Nick Tuffley, senior economist at Westpac Bank.

"They’re still saying that the data’s not entirely convincing as to whether the housing market is slowing," he says.

Tuffley says it’s been difficult in recent months to predict how the Reserve Bank will react to developments. The fact that the latest consumer price index and gross domestic product figures were weaker than expected didn’t appear to have swayed today’s decision.

"The relative weights of what’s important and what isn’t seem to be quite fluid from one statement to the next."

Anthony Byett, chief economist at ASB Bank, agrees there has been a degree of inconsistency in the central bank’s last few decisions, but that the market shouldn’t be too critical of this.

"It reflects the very mixed nature of the economy and also the likelihood that we’re not looking at big rate increases," Byett says. "It’s more about fine-tuning where interest rates are."

David Drage, chief economist at ANZ Bank, says Bollard would have ignored the currency move if the other inflation pressures hadn’t been present.

The decision also reflects "the continued extreme level of resource pressures and domestic pricing pressures generally," he says.

Despite the recent currency fall, Bollard says the delayed impact of the recent high exchange rate and a further fall in net immigration may dampen inflation and reduce the need for further rate hikes.

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