Kiwi Rates Up

Sydney, June 8, 2007 (ABN Newswire) - Crunch! That was the sound of the New Zealand export sector snappingas they, along with most in the financial markets, were shocked by the lift in the country's Official cash rate to a high 8 per cent.Most commentators said a rise was more likely later in the year, but the Bank of New Zealand late last week reckoned a rise could be on the cards.

It was.

The hike was the third this year and the 12th since Dr Bollard started his credit squeeze at the beginning of 2004 when the OCR was 5 per cent. New Zealand's official rates were already the highest in the developed world and compare with Australia's rate of 6.25 per cent.

Reserve Bank Governor Alan Bollard said yesterday, "A sustained period of slower growth in domestic activity will be required to alleviate inflation pressures. A 60 per cent surge in world prices of dairy products the past six months has boosted farmers' incomes and will stoke inflation next year."

A Policy Assessment Statement issued on the RBNZ website explained the reasons why the rate was increased.

"Domestic demand has grown strongly since late 2006, particularly in the household sector.

"Housing market activity has been buoyant, consumer confidence has remained relatively robust and a range of business sector indicators, including employment and investment intentions, have been strong.

"As we have noted recently, government spending continues to increase, which is contributing to domestic demand.

"Following several years of strong growth, firms have indicated that capacity remains stretched and that finding both skilled and unskilled staff has become increasingly difficult. These pressures continue to underpin inflation.

"A sustained period of slower growth in domestic activity will be required to alleviate inflation pressures.

"Lending rates have risen significantly in recent months, partly due to previous increases in the OCR. Given the usual lags, we have not yet seen the effect of these increases on domestic demand and inflation pressures

"There are some early indications from recent opinion surveys and other data that growth may be starting to soften, but these are by no means conclusive. Indeed, at present the risks to domestic activity appear to remain on the upside.

"A significant development in the past six months has been a marked increase in dairy prices. While there are uncertainties about the future path of these prices, the increases will assist in narrowing New Zealand's trade deficit.

"The rise in dairy sector incomes will provide a substantial boost to economic activity over the next few years, but will also add to inflation pressures.

"Parts of the export sector outside the dairy industry will continue to face challenging conditions due partly to the New Zealand dollar. As we noted in April, the exchange rate is at levels that are both exceptionally high and unjustified on the basis of New Zealand's medium-term fundamentals.

"Had we not increased the OCR this year, it is likely that the inflation outlook would now be looking uncomfortably high.

"This further increase in the OCR is to ensure that inflation outcomes remain consistent with achieving the target of 1 to 3 percent inflation on average over the medium term."

The Kiwi dollar surged to a new all time high immediately after the decision: it hit 75.67 US cents, the highest since it began floating in March 1985.

New Zealand was not alone in raising rates to combat inflation. The European Central Bank yesterday raised its benchmark to a six-year high of 4 per cent.

The Bank of England left its benchmark rate steady at a six-year high of 5.5 per cent overnight after four increases in the past year, most recently a month ago. The Reserve Bank of Australia (RBA) also left its key cash rate steady at a six-year-high 6.25 per cent, despite an economy exhibiting all the signs of a low inflation demand driven boom

And in further news yesterday the latest Australian jobs figures showed more jobs were created in May than forecast: the participation rate rose to 65 per cent and the jobless rate fell to just 4.2 per cent, the lowest for more than 33 years.

Despite that boom-like performance and the strong economic growth, there's no sign of pressure on wages or pressure on costs.

In New Zealand it has been a different fashion and the economy is still unbalanced thanks to a housing boom, embedded cost pressures and housing interest rates slow to be impacted by the three rate rises this year because 80 per cent of all home loans are fixed for two or more years.

Bollard and the RBNZ are required to keep inflation between 1 per cent and 3 per cent.

The RBNZ sees annual inflation slowing to 2.2 per cent by March next year and then rising to 2.8 per cent by March 2009.

NZ consumer prices rose 2.5 per cent in the year to March 31, 2007.

The rise in official rates and the prevalence of the yen carry trade has boosted the NZ currency by more than 20 per cent over the past year, which has hurt the country's export sector. Some are closing facilities in NZ and heading offshore to lower cost areas, such as Thailand where Fisher and Paykel Appliances is heading.

The NZ Government responded to this by introducing a tax credit system on foreign income but that won't kick in for nine months or so.

Skellerup Holdings, which exports rubber goods used in medicine and irrigation, this week, said full-year earnings will be cut by more than a third because of the higher Kiwi dollar. The company will follow F&P and close some businesses in NZ and relocate to cheaper areas offshore.

Despite concerns from the huge and influential dairy lobby about the impact of the rising currency, a world wide boom in dairy products has boosted prices 60 per cent. As a result Fonterra, the world's biggest dairy exporter, says it will pay farmers 27 per cent more for milk this year, adding $NZ2 billion to dairy farm incomes in the next two years. (Just imagine how much would have been added without the currency rise.)

The RBNZ now expects New Zealand economic growth will almost double to 3.1 per cent in the year to next March, from 1.7 per cent in the year to March this year.

But the big problem remains the housing boom. Dr Bollard said yesterday "Housing market activity has been buoyant, consumer confidence has remained relatively robust and a range of business sector indicators including employment and investment intentions have been strong".

Home sales rose 8.1 per cent in April from April, 2006 and first retail sales grew in the March quarter at their fastest since the statistics series started in 1995. The contrast with Australia is illuminating as our house sales are unbalanced: madcap in booming Western Australia and Queensland, sluggish in NSW and Victoria. Retail sales though are running at their fastest pace for four years.

For whatever reason, our growth is balanced. New Zealand's growth is not so much unbalanced, more ragged. It's a curious situation.

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