|Investment Research Group|
This could see rates at 4% and even 5% within the year. While this sounds like a lot, it is worth remembering that the rate was 7.25% just a year ago and the subsequent slashing reflected the dire state of the world economy and credit markets.
Australia is moving first because its economy is the strongest. It is the only country in the developed world not to enter recession in the past two years (it had only one quarter of economic decline and two in a row are needed for a recession to be called). Higher interest rates are needed to stop new investment bubbles and keep a lid on inflation.
It does not appear likely that other countries will follow Australia's lead in the short-term. Major economies like the UK, Eurozone and the USA are growing far less rapidly and policy makers are concerned about acting too soon and tipping the economy back into recession.
In New Zealand, interest rates on two year bonds have jumped from 3.75% in July to 4.1% now, suggesting investor expectations for higher inflation and/or a rates rise. However, five-year rates have only moved up a fraction and, curiously, the 10-year bonds have actually fallen, suggesting there is no concern about long-term inflationary pressures.
In September, Reserve Bank governor Alan Bollard noted a patchy economic recovery had begun in this country but that it needed continuing assistance from loose monetary policy, including a low Official Cash Rate (OCR). "We expect such support will be needed for some time. As a result, we continue to expect to keep the OCR at or below the current level through until the latter part of 2010," he said.
While this timetable may well shorten, particularly since central bankers like to surprise markets to beat speculators, it appears to be in NZ's interests to keep rates down. Higher rates would attract more foreign capital to our shores and further boost our exchange rate, which has already appreciated to the point where it is causing pain to our exporters.
As Westpac economists put it recently: "NZ can afford to have more stimulatory monetary conditions than Australia, given the more substantial slack in the NZ economy. However, it could well be that the slack disappears fairly quickly in an agricultural/dairy bounce-back. "
“That said, we see labour market weakness persisting for some time. It is important that the RBNZ bear in mind that they have a bigger tightening job to do once they get going, with the cash rate starting further below its average or neutral level than in Australia."
In April, the Reserve Bank lowered the official rate to just 2.5%, which is a rate well below that of Australia. This is unusual since NZ rates are typically half to a full percent higher than Australia’s (to compensate lenders for the higher risks of our weaker economy). While interest rates in the major economies will rise later and more slowly than in this part of the world, in this country they are likely to go up quickly and steeply once they do begin to move. Therefore, investors need to make sure they are only holding short-term fixed interest securities.