As had been widely expected the Reserve Bank undertook their second interest rate rise in the current cycle this Thursday morning with a boost in the official cash rate to 3.0% from 2.75%. As justification they noted “Overall, we continue to predict respectable near-term GDP growth, with manufacturing confidence remaining elevated and forestry exports continuing to expand. An eventual recovery in business investment will assist growth over the medium term. Annual CPI inflation has been near 2 percent for the past five quarters. As the economy grows, inflationary pressures are expected to pick up.

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Reserve Bank Tightens – But Cautious
And “…it is still appropriate to continue to reduce the extraordinary level of support implemented during the 2008/09 recession.” Those comments were expected, but other comments were more dovish than the markets had been anticipating and perhaps more in line with our underlying view of the economy and warning that the RB may raise the cash rate less rapidly than we were earlier thinking. That is why we have been modelling a two month pause in the Interest Rates section further on in the Weekly Overview.

The RB noted that “Trading partner growth has turned out stronger than we predicted, however, future prospects for growth have deteriorated. While still at high levels, our commodity prices have moderated.” And “In New Zealand, domestic demand is subdued. Households are cautious, with retail spending growing only modestly, housing turnover in decline and household credit growth weak. While this caution has been evident for some time, the recent slowing in net immigration will act to further dampen consumer spending. Business investment remains very low, with corporate lending continuing to be subdued.”

Therefore “The pace and extent of further OCR increases is likely to be more moderate than was projected in the June Statement. Our policy assessment will be continually reviewed in light of economic and financial market developments.”
In other words, there will be future interest rate rises but not with the cash rate heading as quickly to 5% as their June forecast of getting there at about the end of 2011, and perhaps with the peak not being roughly 6% in late-2012 included in those earlier forecasts.

This is therefore good and bad news for borrowers. Bad in that interest rates are still going to rise. Good in that the RB has noted a clear risk of pausing along the way. But as they note, and as we have repeatedly noted, this interest rate cycle is more of a suck it and see exercise than any previous one given the huge uncertainties still in play.

Business Sentiment Eases
The second important thing in the NZ economic sphere this week was the release of the monthly NBNZ Business Outlook survey. As one would expect given the way this survey lags our own results released three weeks ago there was a dip in the net percent of businesses expecting the economy to improve over the coming year to +28% from +40% in June. This is still well above the ten year average of -17%.

More importantly though the activity expectations measure remained well above the 18% ten year average at 32% though this was down from 39% in June. The employment intentions measure eased to 8% from 13% in June but was above the average of 3% and therefore suggestive of good jobs growth in the near future. But consistent with what our other readings are telling us businesses remain reluctant to invest (hence they need people instead) with a net 5% positive investment intentions from 10% in June and an average of 10%.


If I Were a Borrower What Would I Do?
In response to gathering events recently and the RB’s statement today we have adopted a central rate hike scenario of the peak being 5.5% instead of 6%, with one pause in the cycle in January and another in June next year. Modelling this scenario produces an expected floating mortgage rate (TotalMoney) over the coming year of 6.9% versus the one year fixed rate at 6.49%. For two years we forecast an average floating rate of 7.6% versus fixing at 6.99%. For three years we forecast an average floating rate of 7.9% versus fixing at 7.3%.

Our analysis still falls slightly in favour of fixing two or three years rather than floating. So personally I would fix three years expecting that by April next year the floating rate will be above the current three year fixed rate of 7.3%. The floating rate will probably be above the current two year fixed rate of 6.99% come March next year. Read more >>

If I Were a Term Deposit Investor What Would I Do?
I’d still have most short but would place some in the five year term to enhance the average yield while I wait for the short rates to go higher.

Exchange Rates & Foreign Economies
NZD Up For The Week - The Kiwi dollar has ended trading this afternoon near 72.4 cents which is about one cent up from a week ago and six cents up from the low near US 66 cents reached on June 8. During the week the currency
actually traded higher at almost 74 cents but it fell away on general profit-taking overnight and this morning’s more dovish than expected comments on monetary policy by the Reserve Bank.

The Kiwi dollar’s rise early in the week was spurred by a sharp gain in the US sharemarket associated with some better than expected corporate earnings reports. As well, In June the number of new home sales in the United States jumped by a surprisingly strong 24% whereas a gain of 3% had been expected. The rise has made investors pull back on their deepening concerns about the US housing market for now and although one might think this would boost the USD it actually assisted some weakening as improving global risk appetite led to selling of the current safe haven currencies – the USD and Japanese Yen. Stress tests for European banks produced generally less worrying outcomes than feared although the scenario of a debt default was not actually modelled.

Next week the NZD will rise if risk worries dissipate further, or it will fall if worries return. There is no way of knowing which scenario will eventuate, but we retain our view that for the remainder of this year at least the NZD will be well supported by strong commodity prices, our assumption of the world economy scraping by and risk tolerance improving further, and high though not necessarily still rising commodity prices.

On the crosses the NZD has changed exceedingly little – reflecting the fact that a lot of our gains against the greenback were on the back of the USD itself easing against the British Pound, Euro, and Japanese Yen.

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Previous Economic Comment
BNZ Weekly Overview 26 July 2010 >>
BNZ Weekly Overview 19 July 2010 >>
BNZ Weekly Overview 8 July 2010 >>
BNZ Weekly Overview 1 July 2010 >>
BNZ Weekly Overview 25 June 2010 >>