Bollard sparks huge falls in wholesale rates and currency

While Reserve Bank governor Alan Bollard left interest rates unchanged as expected, his latest monetary policy statement sparked a huge rally in interest rate markets and the New Zealand dollar fell more than one US cent.

Thursday, June 5th 2008, 10:01AM

by Jenny Ruth

Bollard left his official cash rate (OCR) unchanged at 8.25% but signalled an OCR cut later this year, "provided the economy evolves in line with our projection."

He is now expecting little economic growth this year, and only a modest recovery thereafter, while inflation is expected to peak at 4.7% in the September quarter this year and won't return to below Bollard's upper target of 3% until 2010.

In wholesale financial markets, the two-year swap rate fell 33 basis points within 20 minutes of the statement being released.

Nick Tuffley, chief economist at ASB Bank, says the market had already been pricing in an OCR cut about October so the market is risking getting well ahead of itself. "The market's been given a green light. It's that sort of knee jerk reaction."

If the currency falls to far too soon, Bollard will be much more cautious about cutting rates, Tuffley says.

Brendan O'Donovan, chief economist at Westpac, who had been predicting no OCR cuts until next year, clearly thinks Bollard is making a mistake.

"It's based on a very heroic assumption that inflation assumptions remain anchored," he says, adding that inflation expectations are already cranking up.

The statement also assumes the economy will remain extremely weak for a very long time. "That's not how I see it," O'Donovan says.

The weaker currency will benefit the manufacturing sector with a lag and the indications are the agricultural sector will have a very good growing season. While the shut-down of housing equity withdrawal has severely crimped consumption for this year, that won't be the case by next year.

"There's going to be a reasonable amount of stimulus through this economy," O'Donovan says. "By his (Bollard's) numbers, he's saying, I don't care about inflation. It smacks of a Reserve Bank that's abdicating its role as inflation fighters."

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