Reserve Bank leaves interest rates on hold

The Reserve Bank is signalling the first interest rate hike around the end of this year, but after that there may be just one rise a year, according to Westpac Bank economists.

But Westpac says it still thinks an extended series of interest rate rises will be needed to rein in domestic inflation, arising from the Canterbury rebuild, even in the face of a strong exchange rate.

As widely expected, the Reserve Bank left the official cash rate (OCR) steady at 2.5 per cent this morning, but said the high value of the New Zealand dollar is hurting exporters.

Stepping up the concern about a strong currency, Reserve Bank governor Dr Alan Bollard said that sustained strength in the New Zealand dollar would keep inflation down and reduce the need for future OCR increases.

The kiwi dollar has risen almost 7 per cent since December, measured against a basket of our trading partner currencies, while export commodity prices tracked sideways, the Reserve Bank said.

“Given the medium term outlook for inflation, it remains prudent to hold the official cash rate at 2.5 per cent,” Bollard said, in a sign that the central bank is willing to keep rates on hold for longer.

ASB Bank chief economist Nick Tuffley said the Reserve Bank put a lot of weight on the high kiwi dampening inflation, in part in an effort to “talk the dollar down”.

“The Reserve Bank is clearly frustrated by the strength of the New Zealand dollar,” Tuffley said. “The tone of the statement is clearly aimed at trying to bring the New Zealand dollar down to a lower level.”

ASB also expected the first rate rise in December, but has now spaced out further rises, every three months rather than at six-weekly intervals.  The cash rate was still likely to peak at 4 per cent, even though the Reserve Bank’s own forecasts imply a peak of 3.25 per cent to 3.5 per cent, ASB said.

The cash rate has been at 2.5 per cent for the past year. The central bank’s projection for 90-day interest rates is on a much more gradual path than it expected in December, rising from 2.8 per cent to 3 per cent by the end of this year and just 3.3 per cent by the end of next year.

Inflation had settled near the middle of the central bank’s target range and inflation expectations had fallen, Bollard said.

The domestic economy was showing signs of recovery.

Household spending appeared to be picking up in the past few months and there seemed to be a recovery in building activity. The building recovery would gain strength later this year as work picked up in Canterbury after last year’s quakes.

High export prices were also helping support a recovery in domestic activity.

Global confidence had improved and while that was “encouraging”, Bollard said financial market sentiment was still fragile and there were still risks for the global outlook.

The easing in global monetary policy and a rising appetite for risk had seen a “marked appreciation” in the New Zealand dollar.

“While helping contain inflation, the high dollar is detrimental to the tradeable sector, undermines GDP growth and inhibits rebalancing in the economy,” Bollard said.

“Sustained strength in the New Zealand dollar would reduce the need for future increases in the OCR.”

The Reserve Bank said the risk of a significant worsening in the global economy had eased since the December Monetary Policy statement.

Earlier fears that the European sovereign debt crisis would badly affect the New Zealand economy had eased after action by central banks in Europe.

The Reserve Bank’s projections show quarterly economic growth of 0.6 for both the December 2011 and March 2012 quarters, picking up gradually to 1 per cent in the December quarter this year.

The projections also show annual inflation tracking well under 2 per cent this year and at 1.5 per cent by March 2013.

The projections also assume a modest fall in the New Zealand dollar over the next few years. If that did not happen the bank would see less need to raise the official cash rate through that time. The trade-weighted index is projected to fall from 72.5 now to 71.2 by March next year.

– © Fairfax NZ News