Interest rates unchanged, as 'tightening' ends

Reserve Bank Governor Alan Bollard

Reserve Bank governor Alan Bollard held the official cash rate (OCR) steady at 7.25 per cent as expected today, and indicated the tightening cycle had come to an end.

Dr Bollard said he did "not expect to raise the OCR further in this cycle".

But the governor echoed previous statements when he went on to say the possibility of a further hike could not be ruled out until there was clear evidence of a sustained weakening in domestic demand.

Dr Bollard ruled out rate cuts in the short term, however, due to ongoing inflationary pressures.

"Certainly we see no prospect of an OCR easing, given the relatively high medium term inflation outlook," Dr Bollard said.

"An early decline in interest rates, as expected by some in the financial markets, would risk reigniting spending and hence inflation pressures."

The RB has raised the key interest rates nine times in the current tightening cycle, which began in January 2004. The rate rises have been part of a concerted effort on the central bank's part to combat rising inflation and curb household spending.

At 7.25 per cent the OCR is the highest official interest rate in the industrialised world.

Dr Bollard said today he remains concerned by the high inflation rate. Annual inflation currently stands at 3.2 per cent, outside the RB's target band of 1-3 per cent. The RB's forecasts point to inflation remaining near the upper end of the target range over the next couple of years.

"Continuing increases in wages, energy prices and other business costs suggest that inflation pressures will not subside quickly. Of particular concern, inflation expectations remain uncomfortably high," he said.

Dr Bollard said the economy had slowed in recent months, but hard evidence of a sustained slowdown in domestic demand had yet to be seen.

"Overall, total spending continues to outstrip growth in production, contributing to an unsustainably large current account deficit," Dr Bollard said.

The $12 billion current account deficit has largely been funded through the bond market, with $25.3 billion in New Zealand denominated bonds issued in 2005.

The RB hit the headlines last week when it emerged officials had visited Japan to try to deter institutions from issuing more uridashi bonds -- which are denominated in kiwi dollars.

The New Zealand dollar rallied sharply on today's news, hitting US68.76c in the first few minutes following the announcement, against its US68.50c local open.

The RB's warning against investing in bonds when the economy is slowing appears to have gone unheeded, with the Bank of New Zealand issuing a $150 million three-year eurokiwi bond overnight.

Dr Bollard's other bugbear -- and until recently a key justification for raising interest rates -- is the buoyant housing sector, although there are signs that may be starting to come off the boil.

Data out from the Real Estate Institute last week showed that both sales and prices eased in December. But the big retail banks have continued to whet home-buyers appetites, pre-empting today's OCR announcement by lowering their fixed term home loan interest rates over the past couple of weeks.

While Dr Bollard may be waiting for hard evidence of a slowdown in domestic demand, New Zealand businesses fear the country is heading for a recession.

The latest business confidence survey released by the economic think-tank the New Zealand Institute of Economic Research showed business confidence slumped in the December quarter to its lowest level since before the 1987 sharemarket crash.

BNZ economists yesterday revised their growth forecasts for this year and next. They said while they still expected a soft landing for the economy a recession was "a real possibility within 12 months".

BNZ is now forecasting 1.7 per cent growth this year, from previous forecasts of 2.4 per cent growth, and 1.5 per cent next year from 3.1 per cent.

- NZPA