Economic uncertainties grow

UNCERTAIN TIMES: Reserve Bank Governor Alan Bollard will take a pause from raising interest rates this week to assess the pace of the global economy, the flow-on effects from Canterbury's earthquake and the failure of South Canterbury Finance.

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Christchurch's massive earthquake and the collapse of South Canterbury Finance have added to economic uncertainties, boosting the risk that the central bank will keep interest rates on hold for the rest of 2010.

The events kill off any chance that the Reserve Bank of New Zealand will raise rates on September 16, although market expectations of an increase had been diminishing anyhow following a string of weak economic data.

Longer term, economic growth could take a hit this year following the 7.1 magnitude quake but then pick up more quickly next year as rebuilding works moves into full momentum, prompting a similar shift in rate expectations.

"The RBNZ will seek to shore up confidence in the first instance, so any remaining chance of a rate hike in the September Monetary Policy Statement has been eliminated," said Westpac chief economist Brendan O'Donovan.

The central bank has raised rates twice this year as the economy emerged from the global economic downturn.

Analysts said further rate rises had been expected as the central bank moved policy back to more normal levels following the global crisis.

But the 7.1 magnitude earthquake on Saturday that caused widespread damage to Christchurch, New Zealand's second-biggest city, raised doubts about those expectations.

Canterbury accounts for about 15 percent of both GDP and population.

Initial estimates for the cost of earthquake damage have been put at around $2 billion, about 1 percent of New Zealand's GDP. But some put it as high as $4 billion.

Business confidence, already on the slide for the past five months, had been shaken by the collapse of South Canterbury Finance earlier in the week due to failed loans.

All 19 analysts polled by Reuters now expect the central bank to keep its official cash rate at 3.0 percent on September 16.

Two weeks ago, they had been split over the need for a rate hike after data showed a slowdown in the housing market, shoppers reluctant to spend and scant job opportunities, raising fears that a recovery was faltering.

Financial markets have been cutting down their expectations for the scale and speed of rate rises because of the weak economic data and a softening global outlook.

On Tuesday, markets were pricing in a 12 percent chance of a rate hike this month, down from 20 percent on Friday and around 80 percent immediately after the last rate rise on July 29.

SHIFT

Financial markets are not pricing in a rate rise for the rest of the year. Concerns of a double-dip recession in the United States add to the policy uncertainty, traders say.

Analysts have a different view. The median forecast of Reuters poll is for rates to rise to 3.25 percent by the end of the year as annual inflation pick ups to 4.5 percent by the fourth quarter due to tax changes from 1.8 percent in the second quarter.

However, Nick Tuffley, ASB Bank chief economist, suggests such a view faces risks.

He says earthquakes elsewhere suggest New Zealand's growth will initially take a hit, but reconstruction activity will subsequently boost expansion by 1.5 percentage points.

"Increasingly, the RBNZ is unlikely to lift interest rates until early next year," he said.

Analysts expect the central bank to rejig its growth and implied rate forecasts following the quake, probably with a sharper rise next year as recovery picks up steam.

"It may well be that policy needs to accelerate its normalisation path further down the track," ANZ-National chief economist Cameron Bagrie said. "We have a lot of sympathy for the notion that the RBNZ does a 50 basis point hike at some stage."

Indeed, the interest swap and bond curve is steepening as investors expect significant stimulus from reconstruction.

- Reuters