Odds on earlier interest rate hike shorten

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The odds that Reserve Bank governor Alan Bollard will start hiking interest rates asooner than later have just shortened.

Tuesday, May 24th 2011, 9:36PM 1 Comment

by Jenny Ruth

The central bank's latest survey showed a sharp jump in two year ahead inflation expectations from 2.6% three months ago to 3%, even as businesses wound down their expectations of how fast the economy will grow.

They now expect the economy to grow 2.1% over the next year, down from the 2.5% annual growth they were expecting three months ago.

The survey results were sufficient to push wholesale interest rates up about five basis points across the board - for example, the two-year swap rate, from which two-year fixed mortgages are set, rose five basis points to 3.32%.

"These are fundamental signals to us that people expect inflation to be running on the high side," says Craig Ebert at Bank of New Zealand, which is expecting Bollard will next raise his official cash rate (OCR) in December. The OCR is currently at 2.5%, its record low.

Given that the economy is emerging from recession and the currency is very high, inflation should be minimal but it isn't, Ebert says. "What worries us is if this is where we're starting from, it can only get worse."

Nick Tuffley, chief economist at ASB Bank, says the jump in two-year expectations "is a reasonably significant move" and means Bollard can't afford to be complacent.

In the past, when the survey showed expectations getting this high, "the Reserve Bank has been a bit twitchy about it."

Tuffley still doesn't think Bollard will raise the OCR until March next year. Bollard will want to be sure the economic recovery is well underway and won't want a repeat of last year when hindsight showed he raised the OCR too soon, he says.

Darren Gibbs at Deutsche Bank says he doesn't think this survey on its own will be sufficient to prompt Bollard to make a material change in his stance.

"At most, we think that it will encourage the bank to remind all and sundry that its ability to support the recovery will depend on wage and price setters acting in a way that is consistent with the bank's medium term inflation target." Bollard's inflation target is between zero and 3% over the medium term.

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