Any further increases would be limited because the soaring kiwi dollar is “acting as a drag” on the economy.
Watching the kiwi dollar climb above 88 U.S. cents this week, one could sympathise with economists who want to sheet home some of the blame to Reserve Bank Governor Alan Bollard.
The official cash rate will be raised by 50 basis points as soon as September, or so financial markets have interpreted his statement last week to mean, and that puts support under the local currency.
The spike in annual headline inflation, to a 21-year high of 5.3% in the June quarter is a “temporary” phenomenon driven by the increase in GST to 15% last October. Underlying inflation is still below 2.5% and that’s what wage and price setters should focus on, Bollard said in his remarkably brief, 209-word statement last Thursday.
We’ll know this week whether wage setters are looking through the inflation spike when the Labour Cost Index and latest unemployment statistics are released. While the unemployment rate is forecast to remain at 6.6%, wage costs probably accelerated, according to a Reuters survey.
Bollard cut the OCR by 50 basis points to 2.5% in March, in a move to ensure easier monetary conditions would help the nation come through the aftermath of the Canterbury earthquakes. Now, he’s signaling he will reverse that as soon as next month. Any further increases would be limited because the soaring kiwi dollar is “acting as a drag” on the economy.
The market believes he has more hikes up his sleeve, albeit a bit further out. The OCR will rise by about 100 basis points over the next 12 months, based on the Overnight Index Swap curve to around 3.5%. Yet even at that level, the OCR would still be below the level that was regarded as ‘neutral’ in terms of stimulating the economy just last year.
Bets on hikes to the OCR roughly doubled through July, as figures showed both the economy and inflation are accelerating at a faster-than-expected clip this year.
However, it’s not conditions at home that have been driving events. Rather, these figures have all been released as global traders began to focus on the conservative wing of the U.S. Republicans digging in their toes on lifting the stupendous US$14.3 trillion debt ceiling. A deal of sorts has been reached, but it was an 11th-hour game of brinkmanship and it has shocked America’s trading partners, including China, the biggest holder of U.S. Treasuries.
The Obama administration looks to have won the ability to keep writing cheques, but even with more headroom to borrow, America’s AAA credit rating may not survive. So the kiwi dollar’s lofty heights have been amplified by negative sentiment towards the greenback.
That sentiment in turn shows just how far the old certainties about the strength of the U.S. economy are being challengede. While some are heading to exotic commodity currencies like the Australian and New Zealand dollars, others are opting for the classic flight to safety presented by precious metals. The price of gold reached a new record and the Swiss franc gained to a historic high against the U.S. dollar.
On July 28, there was little sign Bollard had spooked the horses. The kiwi dollar flitted up and down in the hour after his statement was released – to a mixed reception.
He rightly pointed to a stronger-than-expected domestic economy, that seemed to be unruffled by the quakes, apart from locally in Canterbury. But as an offset, global financial markets were still fragile and uncertainty around the U.S. debt ceiling was adding to the doubts.
Looking in the crystal ball, a couple of months down the track, the U.S. Congress has its agreement to raise the debt ceiling but the credit rating is chopped to AA+. One or two more European economies remain under threat of being subsumed in debt but the Greek crisis eases. China, meanwhile, continues to take small steps to cool inflation.
Here at home, five-year fixed-rate mortgages still look expensive at around 7.75% but the gap between floating and shorter-term fixed may narrow and borrowers should keep a close eye on that gap if they’re planning to switch.