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Bollard Throws Out Rates Lifeline In Face Of Sinking Economy

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Fuseworks Media
Fuseworks Media

By Simon Louisson of NZPA

Wellington, June 5 NZPA - Reserve Bank (RB) governor Alan Bollard threw borrowers an interest rate lifeline today in the face of a rapidly sinking economy and inflation soaring to 4.7 percent.

He held the official cash rate (OCR), as expected, on 8.25 percent but clearly signalled a rate cut this year, possibly as early as September.

"We are now likely to be in a position to lower the OCR, later this year, which is sooner than previously envisaged," he said in his quarterly Monetary Policy Statement.

Why, when inflation is about to hit an 18-year high, was revealed when Dr Bollard painted a grim picture of the economic outlook.

* Household spending -- the main driver of economic growth in the 2000s -- will contract over the next couple of years, despite the Government's announced tax cuts.

* Economic growth will come to a virtual standstill this year and will grow well below par at 1.4 percent in the March 2010 year.

* House prices are forecast to plunge from their peak last year, by 22 percent when inflation was taken into account.

* Unemployment will almost double to 6 percent over the next three years and job creation will go backward over the next four years.

Dr Bollard said that in contrast to past economic contractions "we are projecting a relatively long period of low growth".

Today's statement sent financial markets into a spin, with the New Zealand dollar plunging US1.5 cents while wholesale interest rates fell nearly a quarter of a percentage point at one stage.

Dr Bollard did not consider the economy was returning to the scourge of the 1970s, stagflation -- low growth accompanied by high inflation.

"We're talking about a year of very low growth and a short-term inflation peak."

The bank is not forecasting recession "but we can't discount the possibility".

Ganesh Nana, of independent economic think tank Berl, said today's economic report card was evidence of the failure of inflation targeting.

"That the RB, in their forecast, is prepared to accept four consecutive years of negative or nil employment growth is clear evidence that New Zealanders are paying a very high price indeed for the inflation control and targeting focus of economic policy," Dr Nana said.

"After nearly 20 years of inflation targeting and several years of windfall income gains in the form of favourable commodity prices and terms of trade, that we now face four years of job destruction is a damning indictment of the failure of inflation targeting."

ANZ Bank chief economist Cameron Bagrie said he was very encouraged Dr Bollard was using the flexibility of the RB's agreement with the Government to ignore the near-term inflation spike.

"Bottom line is that we're not getting any growth so that means the medium term outlook for inflation is better and in that situation the Reserve Bank can take an appropriate monetary policy response, which it looks like they're prepared to do."

But Westpac economist Sharon Zollner said the bank was too pessimistic on growth which it predicted at only 0.9 percent in the year to March 2009.

"They're picking a slowdown that's much longer than New Zealand typically sees," she said.

The bank assumes the NZ dollar trade-weighted index will fall 14 percent over three years but said it could fall even more rapidly.

A steady fall was desirable but a steep fall was not, Dr Bollard said.

Wholesale interest rates -- 90 day bank bills -- are assumed to fall from around 8.8 percent to 8.1 percent in the first half of next year, and to 6.7 percent by the second half of 2010.

Dr Bollard did not accept the bank should have moved sooner to signal an easing, saying inflation pressures had been too great.

"I think we have done precisely the right thing."

The bank was forecasting oil prices to fall away but if they do not and it proves to be a structural change, it "means New Zealand is poorer and policies need to recognise that".

He said recognised that to cut rates when inflation was so high risked inflation staying high and embedding higher inflation expectations.

He warned the bank would be watching wage rounds closely.

"We are giving a message to both unions and employers which is `that you have got to be realistic, there are softening conditions in New Zealand that have to be taken into account in negotiations'."

The Engineering, Printing and Manufacturing Union responded by saying workers should not have to pay twice for higher inflation.

National secretary Andrew Little said workers who were already being hit with higher prices caused by international factors should not be expected to forgo pay increases needed to maintain living standards.

"Kiwi workers are seeing more and more of their wages disappear into their fuel tanks and shopping trolleys every week, and telling them to curb their wage claims now is effectively hitting them with a double whammy."

Dr Bollard said stimulus provided by the Government's tax cuts and new spending announced in the budget would provide some offset to the lower growth. They would add to inflation pressure but the additional stimulus provided by the budget was "relatively small" in the context of other factors in the economy.

NZPA WGT sml mgr

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