Global turmoil keeps OCR at record low

Reserve Bank Governor Dr Alan Bollard. Photo / Mark Mitchell

Reserve Bank Governor Alan Bollard has, as expected, left the official cash rate (OCR) unchanged at 2.5 per cent this morning, indicating New Zealand's surprisingly strong local economy remains largely at the mercy of developments in the troubled global economy and financial markets.

"If recent global developments have only a mild impact on the New Zealand economy, it is likely that the OCR will need to increase", Dr Bollard said in his September Monetary Policy Statement.

"For now, given the recent intensification in global economic and financial risks, it is prudent to continue to hold the OCR at 2.5 per cent."

The New Zealand economy had performed "relatively well" while headline inflation "increased somewhat" since the June statement said Dr Bollard.

"At the same time, however, global economic and financial risks have increased."

Activity in the local economy had "surprised on the upside" and capacity usage - a measure of how hard the economy is working - appeared to have increased in recent months.

"Continued high export commodity prices and, in time reconstruction in Canterbury are expected to provide impetus to demand over the projection horizon."
But the outlook for our major trading partners had "deteriorated markedly".

"There is a real risk that global economic activity slows sharply, as during the Global Financial Crisis."

That risk of a global slowdown combined with anxiety about the debt problems in European countries had caused a deterioration in global financial market sentiment which in turn was showing early signs of driving up funding costs for New Zealand's banks.

"The indicative cost of international long-term funding has increased materially for New Zealand banks. Actual bank funding costs have so far been largely unaffected.

New Zealand banks are currently well funded and have not needed to issue term debt recently.

Nonetheless, if conditions do not improve, bank funding costs will eventually increase", said Dr Bollard.

Higher funding costs for banks mean higher mortgage and other lending rates for banks' customers but also higher interest rates for savers.

Meanwhile the New Zealand economy's better performance than many others had driven the dollar higher since the June Monetary Policy Statement.

That was having a dampening influence on "some parts of the tradable sector" including exporters but also on imported inflation - limiting local price increases for imported goods such as oil and petrol.

While inflation continued to run above the Reserve Bank's 1 to 3 per cent target band, Dr Bollard said much of the current "spike" was down t last year's GST increase and would therefore be temporary.

"Wage and price setters should focus on underlying inflation, which, while rising, is currently estimated to be near 2 per cent."

See recent Reserve Bank changes to the Official Cash Rate here.