Bank to keep interest rate at all-time low

Reserve Bank Governor Alan Bollard. Photo / Mark Mitchell

The Reserve Bank is universally expected to keep the official cash rate on hold at 2.5 per cent on Thursday, so the focus will be on what clues the accompanying statement gives on how long it intends to keep it at that all-time low.

A Bloomberg survey of 15 market economists found five, including ANZ and BNZ, expect the first tightening move to occur before the end of the year, while the median forecast for the middle of next year is that rates will be a full percentage point higher.

Since the last OCR review in April the international outlook has become more overcast. Export commodity prices have continued to rise, but the pace of increase has been slowing and improved world prices have been offset by the dollar, which has appreciated 2.5 per cent in the six weeks since the last OCR review, on a trade-weighted basis.

While the bank is expected to express discomfort with the level of the exchange rate, economists do not expect it to display any appetite for intervention at these levels

Renewed rises in global oil prices remain a risk.

On the domestic front, the housing market has perked up but the revival is largely confined to Auckland.

Consumer spending by way of plastic cards rose a brisk 1.5 per cent in April on top of a 1.6 per cent increase in March. But compared with the same period a year earlier the increase was almost entirely confined to the necessities, food and fuel. Discretionary spending continues to struggle.

The Budget froze Government operating spending for the next three years in nominal terms.

But in the near term much of the associated economising will be through lower contributions to KiwiSaver, rather than in forms which reduce household or business incomes.

The bank's June monetary policy statement is expected to emphasise how much uncertainty surrounds its forecasts, especially over the impact of the February 22 earthquake.

"Preparations for rebuilding have yet to begin in any meaningful way, with aftershocks still occurring and the risk of another major earthquake still present," said ASB chief economist Nick Tuffley.

The extent to which the large build-up of debt by households and farms during the last decade will continue to weigh on their spending behaviour is another key judgment the Reserve Bank's forecasters will have to make. Credit growth remains extremely weak.

Business confidence has rebounded but forecasters are wary of putting too much weight on that indicator, which gave a false signal of resurgent activity this time last year.

Inflation expectations have risen in recent surveys to levels above the top of the bank's target range of 1 to 3 per cent over the medium term.

Deutsche Bank chief economist Darren Gibbs expects the Reserve Bank to reiterate that its ability to support the recovery with low interest rates will hinge on price-setting behaviour remaining consistent with its inflation target.

"However , crucially, we expect the bank will retain a fairly sanguine outlook for core inflation and thus once again conclude that the current level of the OCR is likely to remain appropriate for some time yet."

ANZ strategist David Croy points out that the OCR is negative in real terms, whether measured against current, expected or historic rates of inflation.

"More than anything else, the fact that the OCR is negative in real terms is the clearest signal that it is on borrowed time," he said.

"We believe the Reserve Bank will start raising rates in December, taking the OCR to 4.75 per cent within two years. Even then, if inflation expectations stabilise at around 3 per cent, that is a real rate of just 1.75 per cent, which is about 1.5 per cent below the long-term average real OCR."

In its April review the Reserve Bank said it expected inflation to settle comfortably within the target band once GST and other Government policy-driven price increases dropped out of the annual rate.

"We beg to differ," said BNZ economist Craig Ebert.

The BNZ thinks the Reserve Bank is overestimating the amount of slack in the economy and therefore how soon inflationary bottlenecks will emerge as demand revives.

"We reckon the Reserve Bank should signal a gradual unwinding of its extremely low cash rate, not only as a a precaution against rising inflation, but to lean against ongoing flight by households and businesses to potentially vulnerable floating-rate debt."

RBA TIPPED TO KEEP LID ON

The Reserve Bank of Australia is widely expected to keep the cash rate at 4.75 per cent, where it has been since last November, when its board meets today.

But ANZ chief economist Warren Hogan said he expected the RBA to raise the cash rate by 25 basis points over the next three months, in response to the tightening labour market.

"With the unemployment rate below 5 per cent and likely to remain that way or head lower over the next year, the Reserve Bank will maintain a strong tightening bias in its monetary policy."

Job ads in Australia have fallen for the second consecutive month for the first time in almost two years.

- AAP