Interest rates may rise on Thursday

JAMES WEIR
Last updated 05:00 27/01/2014

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A possible rise in official interest rates this week is looking like a close call. But the expectation that official interest rates are going up soon has seen longer term mortgage rates jump, with three-year rates looking the best bet for borrowers, according to a BNZ economist.

That lift in fixed term rates is giving muscle to the Reserve Bank to keep a lid on inflation, even before it starts lifting the cash rate, with several hikes expected this year.

On Thursday, the Reserve Bank is due to issue its one page review of the official cash rate, sitting at a record low 2.5 per cent, with financial market pricing suggesting a move is a 50/50 call.

While some bank economists say the central bank could lift rates this week, that could spark a big jump in the dollar and wholesale interest rates.

Others such as Westpac and ASB expected rates to remain unchanged this week, but for the Reserve Bank to flag a rise in six weeks.

Stronger than expected inflation figures out last week meant that a possible rate rise this week has become "a close call", but ASB economists gave it just a one in four chance.

The floating mortgage rate is presently about 5.74 per cent but Bank of New Zealand economists expect it to hit 6.25 per cent before the middle of the year and near 7 per cent by the end of the year, as the Reserve Bank pushes up the cash rate.

The Reserve Bank's last report in December implied four or five interest rate rises this year, starting in March or April.

But since the end of last year, three year fixed term mortgage rates have already jumped from just under 6 per cent to about 6.4 per cent.

Fixed rates rise ahead of moves in floating rates as they are driven by expectations of where floating rates will go, BNZ said.

BNZ chief economist Tony Alexander said the current three year at 6.39 per cent is where borrowers should fix, with floating rates set to rise sharply this year and the five year fixed rate already at 7.2 per cent.

With many borrowers on floating rates or fixed for less than a year, the rise in official interest rates is expected to bite quickly.

Westpac points out that if the central bank's intentions are clearly signalled, financial markets should lift term interest rates well in anticipation of a hiking cycle, "achieving many of the Reserve bank's goals early".

"That is exactly what has happened . . . term interest rates have already risen substantially," Westpac chief economist Dominick Stephens said.

The floating rate was important and was tied to the official cash rate.

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"Lifting it now would be better- but waiting an extra six weeks is not dramatically inferior," Stephens said.

And Westpac says the Reserve Bank needs to lift rates this year, but if moves them this week, it could spark a big jump in the currency and wholesale interest rates.

"The Reserve Bank has little to gain by hiking in January and much to lose," he said.

If there was no change on Thursday market reaction would be "muted" but a rate rise would spark a large reaction. The dollar could jump about US1 cent and the two year swap interest rate could move up as much as 20 basis points, Westpac said.

Recent economic figures showed rates needed to rise this year, with economic growth probably at more than 1 per cent a quarter in the second half of last year. Business confidence is at its highest for many decades, and consumer confidence is up to seven year highs.

The terms of trade are at their highest levels since the early 1970s.

Westpac also says inflation is rising faster than expected, though remains below the Reserve Bank's 2 per cent target.

With strong economic data, a rate rise this week would be considered and might be a "close call" Stephens said. But the Reserve Bank was more likely to wait till March, before moving rates up.

A rate rise this week would risk sending short term wholesale interest rates higher than the Reserve Bank intended and that would lead to a large rise in the currency.

"The central bank would have to work to unwind any such overreaction later," he said.

In March, a rate rise would be backed up by a five chapter booklet, detailed economic forecasts, a press conference and an appearance before Parliament's Finance and Expenditure Select Committee.

A move then would be in line with the central bank's aim for transparency and communication, unlike a one-page press statement due this week, Stephens said.

- Fairfax Media

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