Bollard leaves OCR steady

Reserve Bank Governor Alan Bollard has left official interest rates unchanged at 2.5 per cent, but is now indicating the first rate rise could be as soon as the middle of 2010, and looks to be giving himself even more flexibility.

In October, Bollard was saying the Reserve Bank expected to keep the official cash rate (OCR) at its current level until "the second half of 2010", and before that he had said the Reserve Bank expected to keep the OCR "at or below the current level through until the latter part of 2010".

Today Bollard said this country's economy continued to recover but considerable uncertainty remained about the durability of the expansion.

"If the economy continues to recover, conditions may support beginning to remove monetary stimulus around the middle of 2010," he said.

"Recent tightening in financial conditions, driven by a higher exchange rate, increased long term interest rates and a wider gap between the OCR and bank funding costs, reduces the need for more immediate action."

But the Reserve Bank also looked to be giving itself more room to manoeuvre. In its quarterly Monetary Policy Statement (MPS) published today, the Reserve Bank said its projections could be overly optimistic or unduly pessimistic.

"If so, the timing of the removal of stimulus could well be adjusted."

Bollard said the economic recovery in New Zealand reflected improved world growth, high export commodity prices, increased government spending and housing strength.

A key uncertainty was the extent to which higher house prices were eventually reflected in increased consumer spending. For now, credit growth remained subdued suggesting households were being relatively cautious, he said.

"While business confidence has improved, actual business spending remains weak. In addition, the high level of the New Zealand dollar has limited the scope for exports to contribute to the recovery."

The MPS said the Reserve Bank expected stronger activity in the housing market to be mirrored by a pick up in residential building.

Consistent with that, retail spending appeared to have troughed, suggesting improved consumer confidence would soon flow through to higher sales.

The impact of recession on the unemployment rate was turning out to be surprisingly muted, as many firms had elected to retain workers. But that could mean the impact of recovery on employment growth was also muted, as increased demand was likely to initially be met by increasing the hours of existing staff, rather than through new hiring or capital investment.

The Reserve Bank expects headline inflation to remain below 2 per cent through calendar 2010. In 2011, partly driven by an assumption the NZ dollar would moderate from the middle of next year, consumer price index inflation was projected to rise to 2.6 per cent, and after that to moderate.

The recession seemed to have simply taken the heat out of inflation, rather than driving it to an especially low rate, the MPS said.

Wage inflation, while easing significantly, moderated to only just below average, while construction costs hardly declined despite contraction in building activity, and rents held broadly steady despite house prices falling about 10 per cent.

- NZPA