Investors underestimate need for Bollard to lift interest rates

The run of bad economic news from overseas is blinding local investors to the likelihood of higher interest rates.

Investors in both New Zealand and Australian fixed income markets have tended to focus exclusively on developments in the US economy and financial system, says Harbour Asset Management’s head of fixed income, Christian Hawkesby.

The Reserve Bank is to review the official cash rate this morning and although he did not expect governor Alan Bollard to raise the OCR above its present level of 2.5%, Mr Hawkesby said investors should be prepared for higher interest rates sooner than the market is currently pricing in.

The overnight index swap (OIS) markets are only pricing in a gradual increase in the OCR, to 3% by the middle of next year.

“We think the market is underestimating the need for the Reserve Bank to get on with things once the threat to the international financial system settles.  In that respect, in their upcoming Monetary Policy Statement, the Reserve Bank would do the market a service by setting out the facts in an impartial way and putting global developments in proper context. “

Commodity prices, retail sails, the recent business and consumer mood surveys and building permits have all been positive over the past month, and inflationary expectations are comparatively high.

“When Dr Bollard reviewed the OCR in July he effectively said he was ready to pull the trigger and put the rate up in September, subject to global markets remaining calm and also the exchange rate not doing too much of the work.”

The combination of financial market volatility and a high dollar now puts back the need for a rate rise, probably until December.

“Effectively, the markets in New Zealand and Australia have been fixated on what is going on globally at the expense of looking at how the local economies are turning out. 

“The Reserve Bank of Australia has been quite good at stepping back from the global turmoil and setting out the facts about the domestic economy.”

Holding off a rate rise this Thursday made sense, he said, following the recent volatility in the US market.

There is still a risk of liquidity problems for banks coming out of the US and that could affect the local situation, as it did in late 2008-early 2009.  A rate rise now would only cause more problems, he said.

“But once these types of fears begin to pass I suspect the Reserve Bank will have to move quite quickly.”