Rate rises nearing peak

The Reserve Bank has raised its Official Cash Rate (OCR) from 5.5% to 5.75%, but has also signalled that further increases are less likely than it was indicating in May.

Wholesale financial markets were little changed after the bank’s decision was announced with the 90-day bank bills trading at 6%.

The major trading banks will have little justification in raising their floating mortgage rates on the back of today’s decision. In fact, movements in longer-term rates in the wholesale markets suggest the banks may even lower their fixed interest rates.

All five of the major home lenders are currently charging 7.75% for floating rate mortgages, well within the usual 150 to 200 basis point margin above the 90-day bank bill rate.

One-year swap rates are currently 6.29% and the normal margin the banks apply is about 100 basis points. Their one-year fixed rates are currently 7.5%, with the exception of Bank of New Zealand at 7.49%, giving the banks room to cut about 20 basis points off their one-year rates.

Similarly with the three-year fixed rates which are currently at 7.75% compared with the swap rate at 6.69%, giving the banks room to cut about 25 basis points.

Today’s move removes the last of the stimulus the central bank applied in the wake of the September 11 terrorist attacks.

"Adjusting interest rates so that they no longer actively encourage accelerated spending makes sense, given that the momentum of the New Zealand economy seems at least as strong as anticipated in May, says Reserve Bank acting governor Rod Carr.

"Retail sales are at near record growth rates, helped along by very robust immigration flows, a strong tourist inflow and export incomes, though they are declining, are still at historically very healthy levels. Given the weakness of the world economy, recent overall growth performance has been outstanding," Carr says.

But the New Zealand dollar has risen much more sharply than the central bank was expecting in May which has effectively tightened monetary conditions, he says. The currency has risen from about 45 US cents in May to nearly 49 US cents.

"If the exchange rate appreciation is sustained, or goes further, some heat will be taken out of future inflation pressures, reducing the extent to which interest rates may need to rise in the months ahead."

Also taking pressure off the need for further interest rate rises is the carnage in global sharemarkets which suggests the US economic recovery, and therefore the global recovery, is more "fragile."

And the signs are that New Zealand’s inflation will peak in the next two quarters at a slightly lower level than previously expected, Carr says.

The latest figures showed inflation at 2.6% in the year ended March.