Reserve Bank set to begin tightening cycle with first OCR hike since 2010

The Reserve Bank is expected this week to act on its concerns that inflation will accelerate as the economy gains momentum by lifting its benchmark interest rate for the first time since July 2010.

Governor Graeme Wheeler will raise the official cash rate a quarter point to 2.75 percent on Thursday, according to 15 of 17 economists in a Reuters survey. In a year's time, the OCR will be at 3.75 percent, according to the median expectation of economists.

The Reserve Bank has held the OCR at a record low 2.5 percent since March 2011, a move similar to most of the world's major central banks seeking to stimulate economic growth after the global financial crisis froze credit markets.

That's coming to an end as the Federal Reserve notes a stronger US economy and sounder financial system and hints at further winding back of its bond buying programme. But New Zealand will likely lead the pack, widening the interest rate gap with other developed economies, as the nation benefits from booming demand for its soft commodities, a pickup in home building, and increasingly confident businesses and consumers.

"With the economy moving closer to full capacity, home-grown inflation pressures are on the rise again," said Michael Gordon, senior economist at Westpac Banking Corp. With this week's monetary policy statement "the Reserve Bank will finally begin the journey back to more normal interest rate settings, after several years of economic underperformance, false starts and major setbacks."

Wheeler gave a clear signal to financial markets on Jan. 30 that interest rate hikes were imminent, saying New Zealand's economic expansion "has considerable momentum." While annual inflation was a relatively tepid 1.6 percent in 2013, Wheeler said forward looking measures of firms' pricing intentions "have been rising."

Since then the Reserve Bank's quarterly survey of expectations has shown businesses expect inflation to speed up to 2.03 percent in the coming year, just above the mid-point of the bank's target range, while economic growth is seen rising to 3.23 percent from the 2.96 percent pace predicted in the December quarter. Westpac forecasts gross domestic product will exceed 4 percent this year.

ASB chief economist Nick Tuffley says a key takeaway from this week's MPS will be how the bank signals the pace of the tightening cycle, which is likely to be gradual. Any sign of a follow-up hike in April could indicate Wheeler sees the need for more rapid action.

"After such a long period of low rates, increasing the OCR rapidly would be a risky strategy no matter the apparent strength in the economy," Tuffley said in a note. "But given the strength in recent data, the risks are clearly skewed towards bringing forward a bit more of the tightening cycle to this year."

Before the April 24 OCR review, Wheeler will have the benefit of having seen data for fourth-quarter GDP on March 20 and the consumers price index for the first quarter, due on April 16. ASB's Tuffley says these "are likely to reinforce the view of lifting economic momentum."

(BusinessDesk)