Bollard holds OCR steady at 2.5pc

Reserve Bank Governor Alan Bollard. Photo / Mark Mitchell

Reserve Bank Governor Alan Bollard kept the official cash rate at a record low 2.5 per cent, as expected, saying the outlook for core inflation and the ongoing economic impact of the earthquakes mean there's no need to raise interest rates any time soon.

"The outlook for the New Zealand economy remains very uncertain following February's Christchurch earthquake," he said in a statement today.

Bollard kept the OCR unchanged even though annual inflation was 4.5 per cent in the first quarter - well above the 1 per cent-to-3 per cent range he targets under the Policy Targets Agreement. The annual rate jumped after the government hiked goods and services tax to 15 per cent, other levies rose and fuel prices soared. Still, looking through the 'shocks', core inflation was more subdued.

"Given the outlook for core inflation and continued economic disruption stemming from the earthquakes, the current level of the OCR is likely to remain appropriate for some time," Bollard said. "Annual inflation is expected to settle comfortably within the target band once these tax increases drop out of the annual rate."

Bollard slashed the OCR by 50 basis points last month as "insurance" against the impact of the quakes though economic figures since then suggest a localised effect, with signs elsewhere in the economy that growth is returning. That includes Auckland's housing market. Activity is the rest of the country "appears relatively unaffected" while rising global prices for commodities is causing a pickup in on-farm investment, Bollard said today.

National Bank's Business Outlook survey, released yesterday, showed business confidence rebounded this month after plummeting in March.

"The rebound in business sentiment keeps alive the debate about whether the RBNZ will move to take away the 50 basis point earthquake-related 'insurance' cut at the end of this year or at the beginning of next," said Robin Clements, senior economist at UBS New Zealand, in a note yesterday. "The rebound was sufficient to be consistent with our profile of recovery."

Bollard is set to raise the benchmark rate by about 70 basis points over the next 12 months, based on the Overnight Index Swap curve.

The New Zealand dollar climbed to a new three-year high above 80 US cents before the statement, driven by further weakness in the greenback after Federal Reserve chairman Ben Bernanke gave what was seen as a more dovish post-FOMC statement than was expected. A weak US dollar and Middle East unrest has also driven up the price of crude oil.

"Higher oil prices and the elevated level of the New Zealand dollar are both unwelcome," Bollard said. "They will have some dampening effect on economic activity."

In the March Monetary Policy Statement, the central bank projected economic growth to be "quite weak" through the first half of 2011, before starting to accelerate as the massive reconstruction of Christchurch gets underway. Bollard made no mention today of the stimulatory effects of the rebuild.

Bollard said in a speech on April 11 that prices for the nation's export commodities are likely to remain elevated for some time. Demand from a growing middle class in emerging economies, especially in Asia, for high protein foods and building materials signals a structural shift rather than the typical boom and bust cycle of commodities.

There is a risk that high prices feed through into consumer spending and borrowing habits, which could stoke inflation and lead to higher interest rates, he said then.

"Trading partner growth remains robust, helping push New Zealand's export commodity prices higher," Bollard said today.

Nick Tuffley, chief economist at ASB, said in a note before today's statement that interest rates "are likely to increase relatively swiftly once the RBNZ sees recovery in the underlying economy over 2012."

See changes in the OCR here.