To hike, or not to hike?

Economists believe the proviso the Reserve Bank gave in April to remove policy stimulus has been met - the economy has continued to evolve as projected.  

Tuesday, June 8th 2010, 5:56PM

by Jenha White

As a result BNZ, ASB, Westpac and ANZ all expect the Reserve Bank to raise the Official Cash Rate (OCR) by 25 basis points to 2.75% on Thursday. J P Morgan however, believes the first hike will be in July.

BNZ Markets Outlook says since April domestic news, on balance, has been stronger than Reserve Bank expectations.

It says in particular the labour market isn't as slack as anticipated (a sharp drop in Q1 unemployment from 7.1% to 6%), commodity prices are higher than expected and world prices for New Zealand export commodities are, on average, around 10% higher than the Reserve Bank had factored into its forecasts. The Reserve Bank also knows the details of the 2010 Budget.

ASB Business Weekly says the Reserve Bank will also want to act soon to start keeping inflation pressures in check. Two year ahead inflation expectations have continued to edge towards the top of the Reserve Bank's target band of 3%.

"Combined with tobacco excise taxes, higher ACC levies, implementation of the Emissions Trading Scheme and GST increase expected to boost annual CPI inflation to 5.7% by mid-2011, the Reserve Bank's assumption that inflation expectations will remain anchored will be put to the test," it says.

ANZ Market Focus says global ructions with financial market volatility and concerns over contagion from Europe complicate the picture for the Reserve Bank and encourage more caution.

Regardless it expects an OCR hike "but if we see considerable market ructions in the lead-up to the review, the decision will likely be a line ball call, such is the nature of markets at present".

ANZ also believes the Bank of Canada's decision to raise rates last week despite market jitters set a useful precedent for the Reserve Bank.

Westpac Weekly Commentary says it expects the ‘policy guidance' paragraph of the Reserve Bank media release on Thursday to be along the lines of: "we will continue to steadily remove policy stimulus provided that global and domestic conditions evolve as expected".

Westpac believes this would make it clear that an extended tightening cycle is underway, but should dampen any expectations of larger 50 basis point hikes and would leave scope for pauses along the way if necessary.

J P Morgan Weekly Prospects has a different view however. It believes the Reserve Bank has scope to sit on the policy sidelines because the domestic recovery is patchy and there is considerable uncertainty surrounding current financial stresses in the Euro area. It is forecasting that the first hike will be in July.

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