Rate rise widely expected this week

Economists expect the Reserve Bank will raise the official cash rate (OCR) this week with much of the debate centring on just how much.

Sunday, December 4th 2005, 10:05PM

by Jenny Ruth

The OCR currently stands at 7% and the most likely decision on Thursday is that Reserve Bank governor Alan Bollard will raise it to 7.25%, although there's an outside chance he could raise it to 7.5%.

Deutsche Bank chief economist Darren Gibbs says he can think of several reasons Bollard may opt for the latter option, including a desire to send a strong message against hectic spending to households ahead of Christmas.

The central banker might also take a punt on a bigger rate hike leading to lower New Zealand dollar if the market could be convinced such a hike will mean greater certainty that domestic demand will slow.

The big risk of such a move is that "rather than decline, the exchange rate might strengthen significantly further for a period as New Zealand's yield advantage is further stretched," Gibbs says.

New Zealand's relatively high interest rates have been attracting foreign investment and bolstering the dollar, hurting exporters but helping to encourage consumer spending on cheap imports.

Tony Alexander, chief economist at Bank of New Zealand, says Bollard will have to weigh up his desire to give "a kick in the head" to consumer spending against the risk of pushing the economy into a recession next year.

He thinks a 25 basis point hike is most likely.

UBS economist Robin Clements says he's expecting a 25 point rise but doesn't think it's necessary.

"Our view is that the 'stronger for longer' economic cycle has been largely a function of changing lags/circumstances. Just because the growth headwinds haven't impacted as quickly as expected, doesn't mean they won't."

But facts Bollard is likely to be loathe to ignore include the unemployment rate at a 23-year low at 3.4%, signs of rising labour costs, house price inflation running at 16.8% in the year ended October and continued strong credit growth.

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