Bank set to hold rates at 2.5pc

The Reserve Bank is certain to leave interest rates on hold at 2.5 per cent this week, despite a strong growth outlook, with the first rise not expected till April or June, economists say.

Westpac says the December and March quarters could show "storming" growth, with a mini-boom in housing and higher dairy prices for the farm sector, but the bank's economists expected rates to stay on hold till the June quarter.

Deutsche Bank economists said it was "virtually certain" the Reserve Bank would hold rates steady on Thursday. It expected only slightly higher near-term growth and inflation. Deutsche Bank expected little chance of a rates rise before April. That depended on how the economy performed, especially in the Christmas period. If spending and borrowing remained subdued, rates could stay on hold for longer.

The central bank was likely to remain concerned about the vulnerable state of many economies, the high level of the New Zealand dollar, whether the recent housing market rebound would be sustained and potential government cutbacks in next year's Budget, Deutsche Bank said.

Bank of New Zealand economists also expected rates to start rising by the middle of next year, but after that borrowers on floating mortgage rates should expect rates to rise about 3 per cent by the end of 2011.

Westpac economists say the recent pace of economic recovery has been faster than expected and the recession has not cooled inflation pressures as much as expected. This week the Reserve Bank was likely to say again that rates would remain on hold till the second half of 2010, Westpac said.

Westpac expected a rise in the June quarter, rather than next December. That earlier start could see rates about 70 basis points higher by the end of next year than expected in September. There may be a clear warning this Thursday of earlier interest rate rises from the Reserve Bank, Westpac said.

The global economy has improved, especially for key markets, including Australia, South-East Asia and China. Trading partner forecast growth for this year and next is 1.1 per cent higher than the Reserve Bank assumed in September.

Economic growth in New Zealand had been steady, not spectacular, but it was set to pick up the pace.

The September quarter was likely to show modest growth of 0.4 per cent. "However, the December and March quarters could be absolute stormers with growth of 1 per cent or more," Westpac said.

Consumers appeared to have stopped cutting back on spending, and asset values and job prospects were improving.

The turnaround was most apparent in the housing market, with prices bouncing back from lows earlier this year to be close to peaks seen two years ago. It was a "mini-boom" with a lift in prices, but still low sales volumes, Westpac said.

That reflected low mortgage rates, rising net migration, and low levels of new home building.

Rising house prices would help boost consumer spending, but would not see a return to the "borrow-and-spend" approach of the past. Rising house prices would encourage more house construction, Westpac said.

Fonterra's international dairy auction prices are up 25 per cent since September. The farmer payout forecast is up to $6.05 a kilogram, also positive for the economy.

Inflation is running ahead of earlier expectations and could be made worse by a couple of one-off factors with higher ACC levies and the introduction of a revised Emissions Trading scheme which will see fuel and energy costs rise.

However, the kiwi has not risen in recent weeks to offset stronger growth and rising inflation expectation, so the balance was tipping towards higher interest rates.

Deutsche Bank pointed out that in recent weeks, the job market was weaker than expected.

- © Fairfax NZ News