Interest rates likely to rise again

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RISING RATES: The Reserve Bank is expected to hike interest rates again this week.

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Interest rates are likely to be driven higher by another official cash rate (OCR) increase this week, despite warnings that the economic recovery is weaker than anticipated.

The Reserve Bank is widely expected to lift the OCR by 0.25 per centage points to 3 per cent on Thursday, the second consecutive month it has raised the rate.

In a bid to stimulate the economy out of recession, the Reserve Bank began cutting the OCR in mid-2007 until it reached a record low of 2.5 per cent in April 2009, where it remained until last month.

Last month governor Alan Bollard said that, given signs of a strengthening economy, the Reserve Bank would begin removing the stimulus measures which were in place, but that the policy would be reviewed "in light of economic and financial market developments".

Since then, figures showed the economy grew more slowly than expected in the first three months of the year and inflation was below projections, although exports rose strongly, cutting New Zealand's current account deficit.

Westpac chief economist Brendan O'Donovan said current indicators suggest that economic growth would be below the Reserve Bank's forecast of 1.1 per cent for the three months to June 30.

Almost all economists still expect a rate increase this month, given Dr Bollard's previous comments. Darren Gibbs at Deutsche Bank said it was "virtually unthinkable" that the Reserve Bank would keep interest on hold.

Roland Randall at TD Securities said such a move would be seen by the markets as the Reserve Bank "failing its first test of faith" which could prompt a selloff of the New Zealand dollar by currency traders.

Some sectors of the economy have called for interest rates to be kept on hold until there is evidence of a broad-based recovery.

The New Zealand Manufacturers and Exporters Association said last month's rate hike was based on an optimistic reading of economic conditions and that another interest rate increase could damage the recovery. Chief executive John Walley said the recovery was, at best "weak and unbalanced".

"A dip back into recession in Europe or stagnation in China could see commodity prices fall further and very quickly," Mr Walley said.

"The risks posed today by these potential shocks far outweigh any potential inflationary pressures a year or so down the track."

Federated Farmers economics spokesperson Philip York said the pressures which would normally prompt interest rate increases were absent from the economy so far in the current economic cycle.

The housing market was flat and inflationary pressures were coming mainly from one-off factors such as the emissions trading scheme, increased ACC levies and a looming rise in GST.

"Interest rates are a huge expense to farmers," Mr York said. "All [a rate increase] is doing is taking money off the bottom line, if there is a bottom line."

All of the major banks appear to support a gradual increase in the OCR.

Khoon Goh, senior markets economist at ANZ/National, said in Wellington last week that keeping interest rates down would stimulate the economy, but rather than increase productivity it would drive up consumption, fuelling another housing bubble.

"What the historical experience has shown is that if you keep interest rates too low for too long, yes it stimulates the economy, but it stimulates the wrong part of the economy."

- © Fairfax NZ News