11 Mar 2011

Interest rates could rise again before year's end

7:45 am on 11 March 2011

The cost of borrowing could start going up again as early as the end of the year, as the rebuilding of Christchurch gets under way and stokes inflation pressures.

The Reserve Bank cut the official cash rate from 3% to 2.5% on Thursday as insurance against the risk of February's devastating earthquake severely undermining economic activity.

The domestic economy remains weak because of subdued household and business spending, while farmers are using surging global commodity prices to reduce debt.

Reserve Bank governor Alan Bollard says firms' sales had started to recover, bolstering plans to employ and invest more, but the quake may put that at risk.

The cut has been put in place to counter the risk, he says, but no further reductions to the OCR should be needed.

Inflation pressures assumed to be modest

The initial cost of the quake has been estimated at up to $15 billion and the Reserve Bank has already forecast that the economy could tip into recession in the year to the end of March.

Spare productive capacity is currently estimated to be at a level similar to that at the depths of the global financial crisis, so inflation pressures are assumed to be modest.

However, the head of market research at BNZ, Stephen Toplis, says rising food, oil and raw material prices, plus the enormous rebuilding effort, will fuel inflation.

He says that what he calls a "shock cut" may need to be reversed quickly and rate hikes may be needed as early as the end of this year.

The Reserve Bank will next review the official cash rate on 28 April.

Manufacturers to benefit

Meanwhile, the fall in the New Zealand dollar on the back of lower interest rates will help Canterbury's manufacturers and exporters.

However, Export New Zealand executive director Catherine Beard says that while a drop in interest costs is welcome, the priority of most manufacturers remains convincing foreign customers that the region is open for business.

She says manufacturing, which makes up 13% of Canterbury's economic activity and employs about 15% of the region's population, has been relatively unaffected.

The farming sector has also escaped the worst.

The 22 February quake hit sectors like tourism and retail hard, particularly if businesses were based in the central business district.