New Zealand Raises Key Interest Rate to Record 8.25%

New Zealand's central bank raised its benchmark interest rate to a record 8.25 percent and said borrowing costs may be high enough to contain inflation, triggering a decline in the nation's currency.

``New Zealanders have been showing early signs of moderating their borrowing,'' Reserve Bank Governor Alan Bollard said in a statement released in Wellington today. If that continues ``we think the four successive rate increases we have delivered will be sufficient to contain inflation.''

Bollard for the first time signaled he may be done raising interest rates, suggesting New Zealand's dollar will slide from a 22-year high that has forced exporters to close factories and fire workers as profits drop. Bollard has raised rates to curb domestic demand, which is stoking inflation toward the top of the 1 percent-to-3 percent range he targets.

``It's a difficult balancing act,'' said Daniel Wills, economist at ASB Bank Ltd. in Auckland. Bollard ``doesn't want to push the currency any higher, but domestic inflation consumption is very tight and will be very slow to unwind.''

The chance of a rate increase at the central bank's next review on Sept. 13 is 11 percent, according to an index calculated by Credit Suisse. All 14 economists surveyed by Bloomberg News today expect the rate will be unchanged.

New Zealand's dollar bought 79.77 U.S. cents at 3:10 p.m. in Wellington from 80.36 cents immediately before the statement. The currency this week reached 81.10 U.S. cents, the highest since it began freely trading in March 1985.

``This level of the currency has been hurting exports,'' said Bollard. ``The high New Zealand dollar is not sustainable medium term and investors should understand this.''

Dairy Prices

Not all exporters are suffering. Fonterra Cooperative Group Ltd., the world's biggest dairy exporter, raised its forecast payment to the nation's farmers by 27 percent in the year ending May 31, citing surging prices which have doubled the past nine months.

Fonterra's NZ$5.53 a kilogram payout will add NZ$2 billion ($1.5 billion) to farmers' incomes, the central bank estimates. Economists surveyed by Bloomberg News expect Fonterra will eventually pay between NZ$6 and NZ$6.60 a kilogram, swelling farmers' wallets even more.

New Zealand's currency has been buoyed by the so-called carry trade, where investors borrow cheaply in the currencies of countries where interest rates are lower, such as Japan, to invest in assets with higher returns.

Japan's 0.5 percent rate is 7.75 percentage points lower than New Zealand's, which is the highest after Iceland's among countries with the top rating at Moody's Investors Service.

Labor Market

Twelve of 16 economists surveyed by Bloomberg News expected the increase. Four forecast no change.

``The continued tight labor market, high capacity use and rising oil and food prices all point to sustained inflationary pressures,'' Bollard said. ``That is why we are increasing the official cash rate.''

The nation's jobless rate was 3.8 percent in the first quarter. Companies found it harder to find skilled workers in the second quarter, according to a survey by the New Zealand Institute of Economic Research. The labor shortage has stoked wage inflation.

Adding to signs domestic demand isn't slowing, retail sales rose twice as fast as expected in May, according to a government report on July 13. House prices increased at the fastest pace in 13 months in June and credit-card spending jumped 9.1 percent from June last year.

Expectations of higher rates increased after a July 16 report showed consumer prices climbed 1 percent in the second quarter, faster than the 0.7 percent pace Bollard predicted.

Inflation Battle

Central banks worldwide are grappling to curb inflation pressures. Bank of England's policy makers this month increased their benchmark rate to 5.75 percent. The Bank of Canada this month raised its key rate for the first time in more than a year to 4.5 percent.

Traders increased bets the Reserve Bank of Australia will raise its benchmark rate to 6.5 percent next month after a report yesterday showed consumer prices rose faster than economists expected in the second quarter.

``The New Zealand economy is strong,'' said Bollard. ``We are recording continued big increases in international commodity prices, especially dairy, reflecting solid world demand for our products. This is very good news for New Zealand.''

To be sure, consumer and business confidence fell in the second quarter, and not all farmers and exporters are benefiting from high commodity prices. House sales fell and annual immigration slowed.

Business Confidence

A net 9 percent of companies surveyed in by the New Zealand Institute of Economic Research expect domestic trading will increase compared with 16 percent in the first quarter. Fewer companies expect profits will rise.

New Zealand consumer confidence fell in July to the lowest since October last year, according to a poll conducted for Television New Zealand Ltd. House sales dropped 5 percent in June from a year earlier, the Real Estate Institute estimated.

Sheep and beef farmers' revenue may slide 9 percent in the year ending June 30 because the currency's appreciation is crimping export earnings, industry body Meat & Wool New Zealand said in a July 20 report.

``We hold grave fears for the future of our industry,'' Andrew Fenton, president of Horticulture New Zealand, which oversees an industry that exports NZ$2.5 billion of fruit and vegetables a year, said in a statement this week.

This month, closely held Cedenco Foods Ltd, which processes and exports food ingredients, said it will close a factory in the North Island city of Hastings, costing seven full-time and 100 seasonal jobs. In April, Fisher & Paykel Appliances Ltd., the nation's biggest appliance maker, said it would close two plants and move 350 jobs overseas because of the rising currency.

source:bloomberg.com