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Inflation Just Around The Corner - Reserve Bank

The Reserve Bank has, as expected, kept its cash rate static in today's Monetary Policy Statement. However the markets are expected to tighten slightly following the announcement as the bank is forecasting increasing inflationary pressure over the coming 12 months.

Significantly the governor has indicated he is likely to raise the cash rate at the next MPS in three months time - earlier than the market had expected.

The cash rate was set at 4.5% when it was established six months ago and has proved remarkably successful in removing volatility from New Zealand interest rate markets since. Over the six months since 90-day-bill rates have not deviated more than 20 basis points from around 4.7%.

From an economic perspective this is clearly positive as it has provided greater stability in interest rate markets than NZ has seen for a long time. This in turn appears to have worked well in stimulating business activity.

Today the Reserve Bank governor gave a relatively upbeat appraisal of New Zealand's economy - but that, unfortunately, has a downside.

'At the time of writing, it seems clear that the New Zealand economy has been maintaining a growth rate of something like 3 per cent per annum for the last 12 months.' Dr Brash said.

'Credit continues to expand briskly, wages seem to be growing well ahead of productivity, and measured inflation is likely to increase significantly over the next year.'

Wherein lies the rub.

With a shrinking output gap - the difference between the capacity to produce and actual level of production - and better world growth prospects, the governor is expecting inflation to rear its head in the second half of next year.

In order to head this off he is anticipating interest rates will begin to rise shortly with 90-day-bill rates forecast to average 5% in the second half of 1999 and 5.4% in the first half of next year.

On the bottom-line for those with a mortgage this could mean rises in floating rates of up to 1% over the next 12 months beginning latter part of this year.

The money market has already priced in the increasing interest rates in large part with 90-day-bill futures already pricing bills at 5.5% from mid next year. Consequently today's announcement is not expected to make waves except at the short end of the market where a rise in the 90-day-bill rate of 10 to 20 basis points can be expected.


The full text of today's Monetary Policy Statement is available online at http://www.rbnz.govt.nz/

Tables from the forecasts and the governor's overview are in the Business wire.

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