Can the cash rate hold steady, or will house prices push it up?

Despite the Reserve Bank's signal that inflation is back in its cage, Westpac economists say house prices are about to head up on the back of strong immigration, which will push another official cash rate rise.

The Reserve Bank on Wednesday delivered a rise to the Official Cash Rate (OCR) of 25 basis points, taking it to 5.5 percent.

It was the 12th consecutive rate rise, and the cash rate reached its highest level in 14 years.

The Reserve Bank said there were good indications it had peaked and could hold steady into next year, but warned there were still risks.

Westpac chief economist Kelly Eckhold told Morning Report it believed the housing market was about to head up, and along with a strong labour market that could mean a higher risk of more interest rates rises than the Reserve Bank had figured.

"We've basically got population growing at the strongest level that we've seen since about 1961, and our sense is that at that sort of level there's going to be a bigger impact on the housing market and rents and consumption more generally in the economy," Eckhold said.

"Whilst there have been some important factors that pushing down inflation, there's a real risk that there's more work that's going to be required to really make sure that inflation goes all the way down from 6.7 to under 3 percent."

Strong immigration typically affects the housing market markedly, he said.

"Westpac's view is that the housing market has bottomed here ... house prices are going to track up from here broadly in line with inflation in general, but there's a bit of risk around that view, because if you look at the history of how our housing market reacts to immigration surges you can see situations where you have a much stronger housing market than that.

"There's good reasons to believe that you shouldn't necessarily expect a really really strong market where it's going up 10 or 15 percent per annum, because interest rates are quite high here. But it's a pretty big change in the balance of supply and demand in that market, particularly, when from most New Zealanders' perspective they might see that with house prices having adjusted back 15 or 17 percent that it might be a pretty good time to start thinking about getting in."

Westpac had calculated that by August those pressures could mean another cash rate rise, Orr said.

"By August we'll see a couple of months more of migration data, which will be giving us a lot more information about how durable that cycle is going to be.

"And we'll learn a bit more about the housing market and the labour market, because we have to remember the labour market is still really strong, and for inflation to fall as far as the Reserve Bank thinks, it really has to turn around pretty significantly over the next year."

The Westpac team predicted house prices could go up at about the same level as inflation would next year, which it estimated at about a 4 percent rise, but with the risk it could be higher.

Eckhold praised the Reserve Bank's approach.

"We think that the Reserve Bank has actually done a pretty good job in the last year or so of managing these inflation risks, between the Reserve Bank and the US Fed they've been recognised as global leaders in this regard by being proactive"

The Reserve bank gives more detail about its assessment

Yesterday's monetary policy statement was regarded as surprisingly dovish, and the Reserve Bank Monetary Policy Committee had been split five to two between no rise and the 25 basis point rise.

Orr told RNZ business editor Gyles Beckford the split vote was not a fundamental disagreement.

"It was really about a degree of confidence across the committee that we can put this inflation beast back in its cage. Those who were thinking about keeping it at 5.25 still had a bias toward tightening and were talking about just waiting now, whereas others thought 'no, let's just do it and then we can be more confident about the watching, worrying and waiting ahead'."

The committee had considered the impacts from increased immigration and increased spending by the government in this year's budget, he said.

"Both are fully baked into our forward-looking projections. On immigration, it's been very strong, and that helps explain the level of aggregate spending that's been happening in the economy - even while people have been tightening their belts, there have been more belts to tighten.

"And in terms of the government's fiscal position, the Budget - while spending is rising it's not rising as fast as the economy, so it's actually a net contractionary effect on demand in the economy. And we took a lot of notice around the government's investment in pensions for the necessary rebuild across much of the North Island.

"So it's all baked into the projections, but the important part is we're starting from an economy that had lower GDP than expected, lower than inflation expected, and inflation expectations easing."

Orr said even if those factors did lead to a small inflationary impulse, the economy was well placed to cope with it.

"I would hope that at the very least we are in a strong position to be able to react as necessary. But we're also in a position where we know that monetary pressures are constraining spending and inflation pressures, so we are in a position where we can afford to watch, worry and wait."

He did not rule out further cash rate rises, if they were necessary.

"We know that we've got a strong hand, that inflation is easing and that monetary conditions are biting on spending behaviour.

"So we're in a strong position. It's taken a long time to get there. We are 5 or 5.25 percent above where we began this climb in interest rates. We really do want to buy time to observe what's going to happen to the inflation pressure over the next couple of years."

Could the Official Cash Rate be held at this point for an extended period?

Orr said that while the best possible projections now might not be what actually happened, their projections "have shown more or less a straight line with the OCR, from where we are today at 5.5 percent and ... into the middle of next year, and that is our best foot forward".

"So the reason it is staying at that level - at this restrictive level, is because we need to still cool that core inflation, but at this moment we don't think we need to be doing more with the OCR, more just buying patience and time."

Cash rate hikes hurt those most vulnerable - First Union

The cost of living crisis will be made worse by the Reserve Bank's decision to hike the official cash rate and the approach should be reconsidered, a worker's union says.

First Union said it wanted the government to consider putting in places policies to provide more protection for some groups against cost of living pressures caused by cash rate rises.

A household cost index showed 23 percent of direct increases in prices households had experienced in the last year were from rising interest rates, the union said.

The group's policy analyst Edward Miller told Morning Report it was time to consider a different approach.

"At this stage it's just become punitive to working people. The problem with the Reserve Bank's approach is that it punishes the most vulnerable people first and leaves those that are in the best position to be able to weather impacts to their demand in actually a better position - wealthy depositors end up making money from Reserve Bank interventions."

There were widespread detrimental effects, Miller said.

"It's lumping additional costs onto New Zealand farmers - that's leading food prices. The farm expenses price index indicates more than half, 56 percent, of the increase in costs that New Zealand farmers are experiencing is now coming from interest rates and that actually affects our ability to produce commodities that we trade and generate income from as well."

Using cash rates to control inflation was the orthodox economic policy in most of the world, but Miller said there were other examples to consider.

"If we look to other places like Spain for example, where they've used fiscal policy to bring down prices, they have some of the lowest inflation in the eurozone. And if you look to countries like Germany, they've introduced selective price caps on key commodities, particularly on gas which has been leading their inflation.

"I think it's time to think about how we can regulate profit margins as well, because profit has been one of the main drivers leading inflation in this country."

In the 1990s New Zealand had led the way globally in introducing what was then alternative interest rate-targeting policies, and could do again, Miller said. And the government should direct the Reserve Bank to research the potential effects of using these types of alternative policies here.

The union would particularly like it to consider controlling interest by regulating profit margins, increases to corporate income tax and increases to income taxes for the wealthy.