No rates cut - for now: Reserve Bank leaves OCR at 2.75 per cent

Reserve Bank Governor Graeme Wheeler, is expected to drop the OCR. Photo / Mark Mitchell

The Reserve Bank opted to leave its official cash rate unchanged at 2.75 per cent, which was in line with market expectations, but said further reduction in the rate "seemed likely".

The bank's statement left out its by now standard comment about the exchange rate being too high.

Instead, the bank directly linked the exchange rate to interest rates, saying a higher New Zealand dollar would require a lower interest rate path than would otherwise be the case.

The New Zealand dollar, which had been under strong downward pressure in the two hours preceding the Reserve Bank's statement, rallied from US66.60 c to US67.10 just after its 9 am release.

ANZ Bank senior foreign exchange strategist Sam Tuck said the market appeared to be short Kiwi in the leadup to the announcement. He said the currency rallied as the statement did not provide a catalyst to sell.

The Reserve Bank said financial market volatility had eased in recent weeks, but concerns remained about the prospects for slower growth in China and East Asia especially.

"Financial markets are also uncertain about the timing and effects of monetary policy tightening in the United States and possible easings elsewhere," it said.

The sharp fall in dairy prices since early 2014 continued to weigh on domestic farm incomes.

"However, growth in the services sector and construction remains robust, driven by net immigration, tourism, and low interest rates," it said.

Global dairy prices have risen in recent weeks, contributing to improved household and business sentiment but the bank said it was too early to say whether these recent improvements would be sustained.

CPI inflation remained below the 1 to 3 percent target range, largely reflecting a combination of earlier strength in the New Zealand dollar and the 60 percent fall in world oil prices since mid-2014

Annual CPI inflation was expected to return well within the target range by early 2016, as the effects of earlier petrol price falls drop out of the CPI calculation and in response to the fall in the exchange rate since April.

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"However, the exchange rate has been moving higher since September, which could, if sustained, dampen tradables sector activity and medium-term inflation. This would require a lower interest rate path than would otherwise be the case," the bank said.

"To ensure that future average CPI inflation settles near the middle of the target range, some further reduction in the OCR seems likely," it said. This would continue to depend on the emerging flow of economic data. "It is appropriate at present to watch and wait," the bank concluded.

Economists said the bank's statement reinforced market expectations for a final 25 basis point rate cut in December. "We continue to expect the Reserve Bank to cut a final 25 basis points in December, and the statement suggests that remains the more likely outcome," ASB Bank chief economist Nick Tuffley said.