Monetary conditions in the New Zealand economy are determined by where actual market interest rates are being priced between investors and borrowers. All the banks have been paying above 4.00% for six-month retail deposits for the last 12 months. They are now paying closer to 5.00% and a higher interest cost for long-term offshore wholesale funding. If the chart below of six-month retail bank deposit interest rates and the official OCR rate is not included in the RBNZ’s Monetary Policy Statement this Thursday to explain the discrepancy to the masses, it will demonstrate how removed the RBNZ is from reality.

The effective management of monetary policy is substantially compromised if your official interest rates are nearly 2.00% below the true market cost of money. Whilst the RBNZ may need to pause on the OCR increase this week, due to the Canterbury earthquake, they are still required to remove the emergency stimulus of 2.50%/3.00% rates put in place 18 months ago and get the OCR up to the market interest rate levels. When the RBNZ come back to increasing the OCR in upcoming months they will not be “tightening” monetary policy at all, merely returning official interest rates to normal levels and where market interest rates have been for a long time already. Increasing the OCR will have no impact on the banks’ cost of funds and very little impact on the interest cost to borrowers. Therefore, the required OCR increases to 4.50% over coming months are only a catch-up to existing market interest rates and will not influence spending, borrowing and investing behaviour/decisions in the economy.

The RBNZ already know all this, their challenge is to explain it to the public and media (who in particular are only interested in the “tightening” headline without bothering to understand the actual situation with interest rates in New Zealand). Hopefully the chart below will assist that understanding!

Outside explaining the OCR/Market gap in interest rates, the markets will be focussed on the RBNZ’s forward view of the NZ economy. I would expect the RBNZ to highlight the following economic trends and forecasts:-

• High export commodity prices still point to 3.5% plus GDP growth in 2011.
• Weaker domestic data over recent months due to household debt adjustment process, however domestic activity will improve in 2011 as increased rural incomes feed into the cities.
• Inflation never really fell away to low levels during the 2008/2009 recession, therefore under a strong growth scenario they cannot afford to be complacent about 2011 inflation.
• There will be further warnings to employers not to pay high wage settlements as this could push inflation closer to 3.00% later in 2011.
• There are always risks around the fragility of the global economic recovery; however these do not seem to be adversely impacting on our economy too much.
• The building industry was in the doldrums, but an earthquake re-build has fixed that negative in the domestic economy.