14 Dec 2009

Recession fear if banks increase rates too soon

9:11 pm on 14 December 2009

The Employers and Manufacturers Association (Northern) says New Zealand could be pushed back into recession if banks move quickly to raise short-term or floating mortgage interest rates.

The Reserve Bank left the Official Cash Rate unchanged at 2.5% on Thursday but brought forward its timetable for a possible rate increase, as it believes house prices will continue to rise.

Some commentators believe retail banks will respond by raising interest and home loan rates sooner than previously expected.

Employer and Manufacturers Association (Northern) chief executive Alasdair Thompson says most small to medium-sized businesses use homes as collateral and borrow money at home loan rates.

Mr Thompson says the general population, especially people who have lost income, cannot afford to see interest rates go up yet and that would trigger a re-start of the recession.

But Reserve Bank Governor Alan Bollard believes households are not about to go on another spending binge because their house values are rising.

Dr Bollard told Morning Report on Friday a combination of lower mortgage lending and caution by houseowners should temper any surge in consumption as New Zealand recovers from recession.

"People have learned something from this crisis. We're not exactly sure what, and how much and how long it's going to last for, but they're behaving differently now than they did, say 18 months ago.

"That is really important, but we've got to wait and watch a little bit to know just how that's going to work."

NZ dollar continues to climb

The New Zealand dollar has continued to climb since Dr Bollard's statement that he might bring forward an increase the Official Cash Rate to the middle of next year.

In October, Dr Bollard pledged not to start increasing the cash rate until the second half of next year.

The dollar jumped sharply against the US dollar on the back of his announcement on Thursday, reaching as high as 72.9 US cents on Friday morning before slipping back a little.

However, Dr Bollard believes the rise in the currency is an over-reaction to his announcement.

Before the latest statement, Radio New Zealand's economics correspondent reports, the markets put the chance of a March increase at near zero. They now give it a 60% probability.

With Dr Bollard noting improved world growth, higher export commodity prices, increased government spending and strength in the housing sector, the bank has also revised upwards its inflation forecasts for the economy outside of the export sector and now expects unemployment to peak at 6.7% next year rather than 6.8%.