Partner Center Find a Broker

In their last rate statement, the RBNZ hiked the cash rate from 2.5% to 2.75%. That’s was first rate hike in almost three years! Hmm, this could mean RBNZ Governor Alan Bollard and his men are in from some serious monetary tightening…chef.png

According to the accompanying statement, the RBNZ believed that New Zealand has entered a strong recovery phase and that inflation is rising at a healthy pace. However, Bollard may have been the party pooper that day as he mentioned that their future monetary policy tightening moves might not be so aggressive. Does this mean that the central bank would take things slow and not take rates to the next level this month?

Well, some analysts seem to think otherwise since the RBNZ is widely expected to serve up another rate hike in their upcoming interest rate decision.

Analysts are pointing at inflation as the main reason why the RBNZ should hike interest rates. According to the latest inflation expectations surveys, business managers expect that inflation will be at about 2.9% a year from now. Meanwhile, the RBNZ itself predicts that it will be at 2.8% by the end of 2011.Take note, the central bank wants inflation to stick within a range between 1 to 3%, so expectations are looking for the high side.

Moreover, some believe that there are certain risks that will cause inflation expectations to rise. They point to the recently implemented Emission Trading Scheme (ETS), as well as a tax rate hike that could be put into place starting October 1.

Just to make things a little clearer, the ETS effectively puts a cap on the carbon emissions that certain sectors can have. In order to compensate for these restrictions, New Zealand companies must purchase carbon credits in order to keep producing at the levels they want. This would effectively raise productions costs and, of course, these additional expenses will be passed down to consumers to carry the burden.

What’s important to understand is that everyday average Joes do not completely understand the structure behind the ETS program and the tax hikes. They may think that they will raise prices even more than they probably should, which in the end, leaves us with a self-fulfilling prophecy as inflation expectations rise.

Given this, I’m going to go on a limb and say that a rate hike from the RBNZ tomorrow is pretty much a sealed deal. However, I am not sure that the bank’s rate hiking way is the path to take. As I’ve mentioned above, inflation expectations are mostly being driven by taxes and the new ETS program, which means that it wasn’t really due to increased economic activity.

Although the economic outlook and inflation expectations of businesses has improved, hard data (those that deal with sales, capital investment, and labor) show that growth remains weak. These domestic issues, coupled with international risks such as sovereign debt fears in Europe and slow US recovery, make the RBNZ’s aggressive rate-hiking ways difficult to truly accept with open arms.