RBNZ predicts steady rise in interest rates

Reserve Bank governor Alan Bollard raised the official cash rate by 25 basis points to 2.75% today, the first increase in three years, saying the economy is into its second year of a "broad-based" recovery and has largely avoided the recent gloom in the Euro-zone.

Thursday, June 10th 2010, 9:40AM

"New Zealand's export commodity prices have increased sharply over the past few months, boosting export incomes," Bollard said in a statement in Wellington today. The recovery in Asia, Australia and the US "has so far offset weak growth in some other export markets."

The rate hike comes after Bollard kept the OCR at a record low 2.5% for 13 months in response to New Zealand's worst recession in 18 years amid a credit crunch that saw international finance lines dry up, sapping lenders' ability to fund businesses and households alike.

Still, he was more opaque about future rate hikes, saying that although the current outlook and previous signalling dictated today's increase, "further removal of stimulus will be reviewed in light of economic and financial market developments."

In raising rates, he has judged there is sufficient domestic momentum to make up for the drag on global growth from Europe's debt crisis. Europe makes up about 10% of New Zealand's total trade, and Bollard said in the report that the slowdown in the Euro-zone "would only have a small direct impact" on the local economy, with the main impact coming in "upward pressure on the cost of funds to the banking system."

The Reserve Bank has lifted its projected track for the 90-day bank bill over the next two years, which it forecasts will reach 5% in the September quarter next year. Before the statement's release, traders were betting Bollard will lift the benchmark interest rate 163 basis points, according to the Overnight Index Swap curve.

In raising the OCR, Bollard, looked through the impacts of the pending rise in power prices as the Emissions Trading Scheme comes into effect, and the 2.5 percentage point increase in goods and services tax flagged for October.

The central bank expects the "removal of monetary stimulus to have quite a powerful and rapid impact on the economy" due to lenders' already increasing funding costs and the shorter borrowing timeframes among both businesses and households. Still, for this to hold true, the bank says inflation needs to stay in check and households and firms have to keep reining in debt.

Financial institutions have been forced to offer attractive interest rates on term deposits as they shift away from relying on offshore wholesale funding in favour of domestic cash from retail investors. The Reserve Bank said this competition for funding has kept deposit rates about 150 basis points above wholesale rates, and has kept lenders' margins under pressure as the low interest rate environment helped damp mortgage rates.

Bollard's hike is expected to capture a lot more homeowners than in the past, with the average mortgage duration sitting at around 12 months in March this year, while it peaked at almost two years in 2007. The central bank said about 30% of mortgage holders are on floating rates, the highest proportion since the first half of 2004.

"The fact that bank funding costs are higher, long-term interest rates are higher than short-term interest rates, and a greater proportion of borrowers use floating rate mortgages should all reduce the extent to which the OCR will need to be increased relative to previous cycles," he said.

Household deleveraging has played a part in a staid property market this year after returning expatriates and new migrants underpinned support for property prices last year. Since then, moves by the government to clamp down on tax benefits of residential property investment and tougher lending criteria from banks has kept a lid on another housing boom, as values returned to their 2007 levels.

Last month, property values were 5.6% higher than the same month in 2009, weakening for the first time in 14 months, according to QV. Bollard said it appears households are taking advantage of low floating mortgage rates to make large principal repayments instead of buying new houses.

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OCR rises, more hikes expected »

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