Bollard leaves OCR steady

Alan Bollard. Photo / Mark Mitchell.

Reserve Bank Governor Alan Bollard kept the official cash rate unchanged at a record low 2.5 per cent and removed his insistence that rates will remain on hold until the second-half of next year, saying the economy has climbed out of recession and growth was "slightly below trend."

"The economy continues to recover, reflecting improved world growth, higher export commodity prices, increased government spending and housing strength," Bollard said in a statement released in Wellington today.

He shied away from insisting that rates will stay low until the second half of next year, saying the economy was returning to growth and inflation was climbing faster than anticipated.

"If the economy continues to recover, conditions may support beginning to remove the monetary stimulus around the middle of 2010," he said, moving away from his stance that rates will remain at their depressed levels until the second half of next year.

The central bank will have to walk a fine line over stoking economic activity without over-egging it as inflation begins to speed up ahead of Bollard's expectations and the housing market continues to show signs of emerging from the lethargy of the past 18 months.

The Reserve Bank's Expectations Survey found respondents see inflation accelerating to a 2.6 per cent annual pace from 2.3 per cent over the next two years. Prices unexpectedly rose in the third quarter, with the Consumer Price Index increasing to an annual 1.7 per cent, according to government data, ahead of the 1.2 per cent pace forecast by the RBNZ.

"Domestic inflation is proving very stubborn to unwind," ASB economist Jane Turner said in a report before the announcement.

"As the local recovery has progressed, the downside risks to the inflation outlook have diminished rapidly."

The central bank has a benign outlook for inflation, and Bollard said he expects the annual consumer price index will remain below 2 per cent until early 2011 and "track within the target range over the medium term."

The Reserve Bank expects the 90-day bank bill to begin rising in the June quarter next year, when rates climb 0.1 percentage points to 2.9 and increase to 3.3 in the September quarter.

The bank previously forecast this to occur in the December quarter of 2010 and March quarter of 2011, respectively.

Before today's statement, traders had been betting the central bank would hike the OCR by 1.63 percentage points in the next 12 months, based on the Overnight Index Swap curve.

The scale of expected tightening has declined in the past month as Bollard reiterated the divergence of monetary policy between New Zealand and Australia, where rates have been rising for the past three months.

Bollard said he tried to combat the market's tendency to "price some degree of interest rate normalisation" once investors guessed the OCR had hit its bottom by adopting his outlook on how long interest rates would remain depressed.

"We believe this communication has helped reduce the extent to which markets priced near-term OCR increases," he said in his report.

The trade-weighted index for the New Zealand dollar, the central bank's preferred method of tracking the currency, has climbed more than 24 per cent from its low in March, and has damped Bollard's preferred export-led recovery.

"The high level of the New Zealand dollar has limited the scope for exports to contribute to the recovery," he said and the central bank predicts the 90 per cent gain in dairy prices on Fonterra's online auction website over the past four months have largely been offset by resurgent currency.

New Zealand climbed out of its first recession in a decade in the second quarter this year as returning expatriates and an inflow of new migrants helped underpin the housing market, and boost business and consumer confidence, and the bank boosted its forecast for economic growth, projecting 1.1 per cent quarterly gains in gross domestic product in the December quarter next year and March quarter of 2011.

The central bank said unemployment had been tempered by businesses cutting worker hours rather than laying off staff, and was near its trough.

The Reserve Bank cut its projections for the unemployment rate, which is expected to peak at 6.7 per cent next year, down from the 7 per cent forecast in the September statement.

Bollard highlighted the links between monetary and fiscal policy, and said "fiscal consolidation would help reduce the work that monetary policy might otherwise need to do" as the economy returns to growth.

The central bank's main policy tool came under scrutiny after Parliamentarians criticised the big our Australian-owned banks earlier this year for failing to pass on all of the OCR cuts to their customers.

Faster consolidation and tweaks to the tax system could help increase the national savings rate, and lead to lower interest rates on average, he said in his report.

A big uncertainty for the economy is whether consumer spending will follow on from the resurgent property market, with households taking a "very cautious" approach to their spending decisions, Bollard said.

Consumer spending has shown a small spark ahead of the Christmas shopping season, with core retail spending on electronic cards, which excludes auto-related sales, up 0.3 per cent according to Statistics New Zealand, while property values were higher than where they were last year for the second month in a row, according to QV Valuations data.