Bollard's predictions on interest rates welcome

Reserve Bank governor Alan Bollard kept the official cash rate unchanged at 2.5%, as expected, and reiterated a mid-year start to rate hikes, saying the subdued pace of recovery will restrain inflation.

Thursday, March 11th 2010, 12:00AM

by The Landlord

"The relatively sluggish recovery predicted in recent statements continues to play out," Bollard said at the release of the Monetary Policy Statement in Wellington.

"Households are still cautious, with house sales and credit growth remaining subdued. Business spending is weak despite much improved confidence."

Economists, prior to the announcement, predicted a 25 basis point hike in the OCR by June 30 and increases totalling 1.25% by the end of the year.

Today's statement will likely keep that scenario intact. In fact it may even cause some of them to push out their predictions for when rates will start to rise.

Bollard also said today that he doesn't expect interest rates to increase to the high levels seen in 2008. He said that changes to funding costs for banks along with a big shift to shorter term home loan rates were helping the central bank do its job.

Bollard said there had been a shift towards mortgage rates of 12 months or less in duration. This means when the bank does change interest rates it will have a greater impact than when the maturity of the overall home loan book was for terms of two years or more.

"Because of increased bank funding costs, a shortening in mortgage duration and a positively sloped yield curve, we expect this tightening to have quite a powerful and relatively immediate impact on the economy," he said.

A record-low OCR hasn't provided as much stimulus to the economy as might have been expected because banks have faced higher funding costs, Bollard said.

"We expect these costs to persist over the projection, reducing the extent of future increases in the OCR."

The Reserve Bank estimates the marginal cost of bank funding has increased to about 150 basis points above the OCR from as little as 20-30 basis points before the financial crisis.

The projected track of the 90-day bank bill rate is almost unchanged from the December MPS, at 2.9% average in the June quarter, rising to 3.6% in the final three months of 2010, from an earlier prediction of 3.5%.

The MPS notes that recent strength in house price inflation "appears to have been temporary," with activity in the housing market abating.

House prices remain high relative to incomes and affordability has been further hampered by rising mortgage rates.

See a comprehensive list of home loan rates here

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