OCR stays at 2.5% but Bollard warns of hikes to come.

As on expectations the RBNZ held the OCR at 2.5% today. However Alan Bollard did suggest that tightening is anticipated in December but don’t be surprised if it is a 50 basis points increase as the bank is wary of inflationary expectations. The cash rate is expected to peak at 4.75% by the end of 2012 which means a further increase by 175 basis points.

According to the Bank of New Zealand the RBNZ’s inflation view are weighted to the upside. In particular, we note that “the Bank’s policy outlook relies on three key assumptions.
These are that:
– construction cost inflation will be subdued relative to its mid 2000s peak;
– households will continue to focus on reducing debt;
– recent increases in surveyed inflation expectations will be short lived”.

However, the labour market is also worthy of note. The Reserve Bank is forecasting the unemployment rate to fall to 4.5% which one would suspect is below or close to the non-accelerating inflation rate of unemployment – NAIRU. This could add inflationary pressures to the economy. According to Stephen Toplis of the BNZ:

Moreover, the RBNZ falls into the trap of assuming that the current 6.6% unemployment rate will act to suppress inflation near term. But this misses the point that the current youth (those aged 15 to 19) unemployment rate is 27.5%! The next age group is high too. The current unemployment rate of those aged 25 and over is just 4.6%. This is the group from which most skilled labour comes from. It is stretched already so we believe the risk of wage inflation is probably higher than the RBNZ expects.

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