KEY POINTS:
Reserve Bank Governor Alan Bollard has left the official cash rate (OCR) unchanged at 8.25 per cent, as widely predicted, while acknowledging the economy has slowed faster than he expected.
While today's announcement leaves the OCR at the same level it has been at since last July, Dr Bollard's comments may have given embattled householders, struggling under the pressures of high mortgage rates, some hope that the start of cuts to the official interest rate are at least coming into view.
Dr Bollard's key statement today was that given the outlook, the Reserve Bank expected the OCR to remain at current levels "for a time yet" to ensure inflation on average over the medium term was within the 1 to 3 per cent target.
That would seem to give the Reserve Bank plenty of room to manoeuvre if the economy continues its rapid descent.
In his announcement today, Dr Bollard said that economic activity had "weakened more markedly than expected" in the Reserve Bank's March Monetary Policy Statement.
But he also pointed to the impact of repeated increases in food and energy prices which, he said, played a large part in short term inflation being likely to remain persistently high.
"There is a risk that wage settlements respond to these short term price shocks rather than adjusting to the changing economic conditions, thus perpetuating inflation pressures," Dr Bollard said.
Over time, the weaker economy would ease accumulated pressure on resources and reduce inflation pressures, but the labour market was still strong and New Zealand's key international commodity prices remained high. Government spending plans and the possibility of personal tax cuts could also be expected to limit the economic slowdown.
"We see significant downside risk to future activity but upside risks to inflation," he said.
Consumer and business sentiment had fallen sharply, exacerbated by tighter credit conditions, a further decline in the housing market and weaker prospects for world growth.
Financial market turbulence around the world continued to add to an uncertain economic environment, while the dry summer was also weakening short term growth prospects, Dr Bollard said.
A further risk to the outlook was the persistently strong New Zealand dollar which, while helping moderate headline Consumers Price Index inflation, remained a drag on export growth.
Highlighting the challenge facing Dr Bollard, the annual CPI increase hit its highest level in 18 months in the first quarter at 3.4 per cent, and the Reserve Bank expects it to remain above 3 per cent for the rest of this year.
Dr Bollard refused to answer questions explaining his decision.
Any change in the OCR today would have been a major shock, with 17 analysts surveyed by Reuters all having predicted interest rates would be held at 8.25 per cent today.
The poll did show a growing expectation of a rate cut by the end of the year, with some economists expecting the Reserve Bank will need to start cutting aggressively, although others still expect rates to remain on hold until 2009.
"The Reserve Bank's starting to put a lot more weight on the fact things are slowing down. They seem to be wavering on how long they going to be remaining on hold," ASB chief economist Nick Tufley said.
"It suggests we are starting to see the Reserve Bank's stance shift a little bit, and it looks a bit more likely the bank could be cutting by the end of the year, instead of holding off until next year."
UBS economist Robin Clements said the same list of factors was cited - softness on the activity side, but still warning about the upside risks to inflation.
"In terms of policy there's a subtle change, rate on hold for a time, rather than a significant time. I think they've made a step in the direction of being more neutral, but not ready to signal any easing yet."
The New Zealand dollar fell nearly half a US cent to US79.42c on the more "dovish" (accommodating) statement.
- NZPA
