Continuing risks keep OCR at 2.5pc

Reserve Bank governor Alan Bollard. Photo / Mark Mitchell

Reserve Bank governor Alan Bollard has kept the official cash rate on hold at 2.5 per cent, as expected, citing international conditions, in particular the "real risk" that the European sovereign debt crisis could further slow global activity and raise funding costs for New Zealand banks during the coming year.

The key paragraph in his announcement yesterday reiterates September's guidance that if global developments have only a mild impact on New Zealand it is likely the OCR will have to increase. But language about "gradually increasing pressure on domestic resources" has been inserted into it. The "gradually" might be seen as moderating the tightening bias.

Bollard says the domestic economy has continued to expand "at only a modest pace" and that business confidence has fallen back "somewhat".

Bank of New Zealand head of research Stephen Toplis said: "The Reserve Bank, like the rest of us, is weighing the possible negative impacts stemming from ongoing European concerns against the probable pick-up in activity associated with New Zealand-specific developments.

"The bank highlights the reconstruction activity in Christchurch but there's also pent-up demand in residential construction elsewhere, the lagged impact of strong commodity prices, a competitive manufacturing sector and solid employment growth to support activity too."

For now, the upward pressure on bank funding costs in tight credit markets abroad was doing the Reserve Bank's job for it, Toplis said.

One indicator of stress in the funding markets is that credit default swap spreads of the main Australian banks are very high.

ANZ National Bank chief economist Cameron Bagrie said that so far there had been no impact on actual borrowing rates through this channel. "But the longer the global situation remains uncertain, the more likely we will see some impact come through."

BNZ has recently joined ANZ and Westpac in expecting the official cash rate to remain on hold until June next year. Bagrie said the risk was clearly towards later than that rather than sooner.

"This is based on our view that we are starting to see more than a 'mild' impact on New Zealand from the global scene - based on anecdotes as opposed to hard data - and that the consensus is too upbeat on how quickly the European situation could settle," he said.

Crucially for an inflation-targeting central bank, the September quarter consumers price index released on Tuesday was a positive surprise, coming in at 0.4 per cent for the quarter, when the Reserve Bank had been expecting 0.7 per cent.

Once the GST increase and other one-off factors are allowed for, underlying inflation is settling near 2 per cent, the mid-point of its target band, the bank believes.