OCR increases but more moderate pace to come

Reserve Bank Governor Alan Bollard raised the Official Cash Rate (OCR) a quarter point to 3%, while predicting a less aggressive path for further increases - good news for floating mortgage rates.

Thursday, July 29th 2010, 2:30PM

by The Landlord

"While the outlook for economic growth has softened somewhat, it is still appropriate to continue to reduce the extraordinary level of support implemented during the 2008/09 recession," Bollard said in Wellington today.

"The pace and extent of further OCR increases is likely to be more moderate than was projected in the June statement."

While floating interest rates are set to rise after the increase, they won't do so as hard or as fast as previously thought, due to the more dovish angle Bollard took on further increases than was expected.

Recent data and confidence measures point to an economy that has slowed to a more tepid pace of growth, easing pressure on the central bank to embark on an aggressive tightening.

Business confidence weakened for a third straight month, according to the National Bank Business Outlook, with firms seeing smaller profits and reducing plans to hire more workers.

Demand in the housing market has remained weak, net migration is waning and consumers are less inclined to spend as they reduce leverage.

"The momentum evident in activity and inflation is presently insufficient to justify a hike in the OCR at every meeting this year," Darren Gibbs, chief economist at Deutsche Bank, said before the RBNZ statement was released.

Today's rate hike was predicted by all 20 economists in a Reuters survey and they expect Bollard will continue to lift the OCR back to more normal levels, ending the extraordinary stimulus in place since April last year when he cut the OCR to a record low 2.5%.

The RBNZ resumed raising interest rates on June 10. Since then data has shown the economy expanded 0.6% in the first quarter, less than the bank's 0.8% forecast.

The dilemma for Bollard is to predict how inflationary pressures will have emerged over the next 18 months, with a risk that the short-term effects of increased government levies and imposts, such as the costs of the Emissions Trading Scheme, GST hike and ACC charges will feed through into broader inflation expectations.

Inflation is expected to spike to over 5% in the first quarter of 2011 though Bollard has said he sees little ongoing impact, with the GST increase softened by tax cuts. Still, business surveys shows firms are preparing to raise prices and the extent of second-round impacts isn't clear yet.

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