Reserve Bank reversal tipped to be cautious

Evidenceis mounting that the world economy is starting to again find its feet.

It is also clear that New Zealand has fared relatively well among the developed economies.

Westpac chief economist Brendan O'Donovan says the country will soon have to start normalising monetary policy settings, earlier than most other countries.

His view is that the Reserve Bank would take time before acting to remove its stimulus - partly because it was not yet fully convinced that the recovery was secure.

The central bank would want to signal a change in tack that did not cause the market to react violently, he said.

"We expect that Thursday's statement will be the first step along that path by jettisoning the last vestige of an easing bias and removing the expectation that rates will remain `at or below current levels through the latter part of 2010'."

Instead, the bank would probably phrase it in terms such as allowing the OCR to stay at a low level for a "considerable period of time", Mr O'Donovan said.

The Reserve Bank was expected to keep its official cash rate at 2.5% on Thursday.

However, since the September monetary policy statement, there had been evidence of stronger economic activity; stronger business and consumer confidence and inflation; and monetary conditions being tighter than expected because of the rise in long-term interest rates and the New Zealand dollar, he said.

On October 6, the Reserve Bank of Australia became the first major central bank to raise its policy rate.

"The fact that they were first isn't surprising.

"Australia has sailed through the global recession with just one quarter of negative GDP growth, house prices are surging and underlying inflation remains uncomfortably high.

"What is remarkable is the speed at which they moved towards tightening."

There was one lesson the Reserve Bank could learn from Australia, Mr O'Donovan said.

In the past few months, the Reserve Bank had raised concerns about a return to unbalanced growth and a resurgent housing market, but it seemed to have been in two minds as to what that meant for monetary policy.

In contrast, the Australian central bank had some firm opinions on the matter.

It noted in its minutes that the current, very expansionary setting of policy was no longer necessary and was possibly imprudent.

The last thing a central bank wanted to be was imprudent, he said.

"The challenge for the Reserve Bank is to lay the groundwork for the eventual tightening cycle but in a way that doesn't scare the horses.

"They will want to give themselves some flexibility around the timing so they can first satisfy themselves that the recovery is secure and hasn't been stifled by the higher New Zealand dollar," Mr O'Donovan said.

Reserve Bank governor Alan Bollard told Parliament's finance and expenditure committee last week that a high New Zealand dollar was unhelpful but would not be a big factor when considering raising interest rates.

The high New Zealand dollar was a "US dollar story", Dr Bollard said.

"We don't want to see the New Zealand dollar being put under unnecessary pressure again.

"If and when we were to increase rates, would you see that coming through on the New Zealand dollar? Well, you might, but actually the market's already taken that into account . . . they are quite a long way ahead."

There was more activity in the housing market, but the Reserve Bank was not seeing much increase in credit going into housing, he said.

The bank did not want to get into a position where it was forced, as it was in the last cycle, to raise interest rates to a very high level, with the consequent damage it could do.

"We would certainly be talking to banks about credit conditions and requirements before that happened.

"At the minute, we don't have concerns.

"We think we have some room to use more tools - we'd be looking at that over this year," Dr Bollard said.

New Zealand Manufacturers and Exporters Association chief executive John Walley said there was more to the rise in the New Zealand dollar than just the United States dollar's weakness.

"That is simply an excuse for inaction.

"The New Zealand dollar has risen significantly against all of our major trading partners since March, but we have continued to see warnings and no action on this issue."

Sooner or later, there needed to be action on the issue.

The select committee was a rerun of the 2007 inquiry "merry-go-round" between politicians and Reserve Bank officials, he said.

Politicians asked what could be done and the Reserve Bank said nothing.

Neither side took any responsibility for the problem.

"Perhaps we need to pay our public servants in US dollars to see some leadership on the matter."

 

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