Reserve Bank will have to hike OCR to 4% in 2012 to offset quake rebuild inflation pressures, NZIER says. Your view?

By Alex Tarrant

The Reserve Bank of New Zealand will need to raise the Official Cash Rate towards 4% in 2012 as it moves to offest inflationary pressures created by the Christchurch earthquake rebuild, the New Zealand Institute of Economic Research says.

In the NZIER's June Quarterly Predictions, released today, but written before a big jump in business confidence on Tuesday, the Institute said it expected the domestic economy to recover strongly from just 0.3% growth in 2011 to 3.7% growth in 2012.

The RBNZ would leave to OCR on hold at 2.5% through 2011, before hiking it as the economic recovery strengthened and inflation pressures began to flow through due to rebuilding in Christchurch.

However, while domestic conditions were steadily improving, risks to the global economic outlook had risen.

"Deteriorating sovereign credit issues in Europe, uncertainty around the end of the quantitative easing programme in the US, and emerging evidence of a slowdown in the Australian housing market are all causes for concern. In emerging markets like China, economic growth is moderating as authorities tighten monetary conditions to curb inflation," NZIER principal economist Shamubeel Eaqub said.

"Exports prices and volumes have been very strong over recent years and have provided a much needed offset against a deep domestic recession. A slowdown in global growth would weigh on exports and hinder the broader recovery," Eaqub said.

'Household spending still frugal'

The domestic recovery would be gradual but sustainable, as households and the government reduced borrowing.

"Household spending remains frugal, with little growth in discretionary spending. In the latest Budget the government revealed plans to reduce public spending over the next five years to reduce the deficit. This suggests underlying economic growth may average around 2% a year over the next few years, excluding the Canterbury rebuild," Eaqub said

Building inflationary pressures

Despite a gradual recovery, medium term inflationary pressures were building.

"Businesses have been absorbing rising costs in ever thinner margins. Businesses will look to claw back lost margins and raise prices when the economy recovers. This could see inflation accelerate. The Canterbury rebuilding programme is likely to generate construction sector inflation, which may spill over to the wider economy," Eaqub said.

"The RBNZ will need to raise rates next year towards 4% to offset these inflationary pressures. A high NZD is helping to keep a lid on inflation for now. We expect the NZD to remain elevated for some time," he said.