Bollard won't hike rates until recovery firmly underway

Reserve Bank Governor Alan Bollard Photo / Mark Mitchell

Reserve Bank Governor Alan Bollard says he will keep interest rates at a record-low level until risks to the country's economic recovery have abated.

"It is appropriate for monetary policy to remain supportive, given the continued downside risks to economic activity stemming from the Canterbury earthquakes and more broad fragility in the New Zealand economy," Bollard wrote in a column for the Press newspaper.

"It is likely that the OCR (official cash rate) remains on hold until these downside risks pass and the economy begins to recover."

The central bank is watching for signs of inflation as the reconstruction of Christchurch begins, and Bollard flagged labour, materials and equipment, and the availability of finance as the likely drivers of price rises from the rebuild. He said construction is expected to begin in 2012 with the deterioration in activity likely to end by the middle of this year.

Bollard cut the benchmark interest rate half-a-percent to 2.5 per cent in response to the February 22 quake in Christchurch, which killed more than 180 people and caused some $15 billion of damage.

Philip Borkin, economist at Goldman Sachs & Partners New Zealand, said Bollard's comments on inflation are "a touch more hawkish" than previous statements, though the bank doesn't appear to be prepared to tighten monetary policy yet.

"With downside risks still present, and some time before we believe the economy will be showing clear signs of a robust recover and enough to absorb spare capacity and start generating inflation pressures, we remain comfortable with our expectations of hikes beginning in March 2012," Borkin said.

"Key to watch, though, is how quickly reconstruction activity begins and underlying inflation gauges rise."

Traders are betting Bollard will hike the OCR by 59 basis points in the coming 12 months, according to the Overnight Index Swap curve.

New Zealand inflation was milder than expected in the first quarter, with a 0.8 per cent increase in the Consumer Price Index in the three months ended March 31, for an annual rate of 4.5 per cent, according to government data.