OCR stays at record low 2.5pc

The Official Cash Rate

Reserve Bank Governor Alan Bollard held the official cash rate at 2.5 per cent, as expected, saying the economy's outlook has improved and the impact of the February 22 Christchurch earthquake hasn't dented the nation's fortunes as much as feared.

Read his full monetary policy statement here.

"While many firms and households - particularly within Canterbury - continue to be adversely affected, it appears the negative confidence effect of the earthquake on economic activity through the rest of the country has been limited," Bollard said in Wellington today.

Bollard kept the OCR unchanged as the economy showed signs of life, after a tepid recovery was knocked by the Christchurch earthquake, which killed more than 180 people and caused an estimated $15 billion of damage.

In March, the central bank shaved half a percentage point from the benchmark rate in a bid to shore up confidence in response to the quake.

"Despite some continuing signs of weakness in the world economy, commodity prices remain very strong and firms expect to increase their hiring and capital investment," Bollard said. "Reconstruction in Canterbury is projected to add about two percentage points to GDP growth over 2012, and boost the level of activity for several years thereafter."

The upbeat tone mirrors the latest National Bank Business Outlook, which showed a rebound in firms' confidence and reversed the immediate slump after the February quake.

Bollard said the "pace and timing of (OCR) increases will be guided by the speed of recovery," though the 90-day bank bill rate, which is seen as a proxy for the benchmark rate, is forecast to rise to 3 per cent in the December period, increasing to 3.4 per cent the following quarter.

Before the announcement, traders were betting the bank will hike rates 56 basis points over the coming 12 months, according to the Overnight Index Swap curve.

The bank gave its first full forecast since the quake, and is picking the economy to grow 2.8 per cent this calendar year. The forecast for March 2011 gross domestic product growth rose to 1.2 per cent from 0.9 per cent in the March MPS, with the economy is expected to surge 4.6 per cent in the 2013 year.

"We expect a slightly smoother GDP growth track compared to March, with stronger near-term prospects, but a lower peak growth rate in 2012/13 as the tighter fiscal stance kicks in," Westpac Banking Corp. chief economist Dominick Stephens and economist Michael Gordon said in a note before the release.

"An upward shift in the exchange rate track will help to dampen price pressures, with inflation likely to remain well within the 1-3 per cent target band over the forecast horizon," he said.

Bollard complained about the strength of the currency, which hit a 26-year post-float high 82.64 US cents last week, saying it is "constraining rebalancing of the New Zealand economy."

Still, the New Zealand Institute of Economic Research says the strong currency is helping keep inflation at bay and giving Bollard room to hold the benchmark interest rate at a record-low. The MPS acknowledged the currency's appreciation was acting to tighten monetary conditions.

The kiwi dollar jumped to 82.07 US cents from 81.50 immediately before the release.

Even without the reconstruction effort, GDP growth is likely to be "quite robust" given the strong prices producers of raw materials are enjoying, the bank said.

Surging commodity prices have underpinned the economy's recovery, with locally produced raw materials netting record prices for the past nine months. That helped drive a record monthly trade surplus in April, and has dairy exporter Fonterra Cooperative Group looking at a record pay-out to farmers.

The bank expects headline annual inflation to come back within the 1 per cent to 3 per cent target band in the December quarter, when the impact of the government's hike in consumption tax last year filters through the system. The annual pace of the consumer price index is forecast to peak at 5 per cent in the three months ended June 30.

Underlying inflation remains "constrained," and isn't expected to pick up until the economy starts moving, and the bank will gradually lift rates to keep it close to the target band's midpoint, Bollard said.

Inflation expectations have increased, with respondents to the RBNZ survey picking the CPI to reach 3.12 per cent in a year's time, up from the previous 2.87 per cent forecast. First quarter inflation was a lower than expected 0.8 per cent, according to government data.

Bollard said house prices are expected to increase modestly over the coming years due to the subdued household consumption, and will be at or below the forecast rate of inflation.

Property values were largely unchanged last month, according to QV data, and are now 1.6 per cent lower than the same time a year ago. The property market has begun showing signs of life after spending the last couple of years in the doldrums as households shied away from debt in favour of repaying loans and shoring up their balance sheets.

The historically low level of interest rates has more than half of home borrowers on floating mortgage rates, with the average length of a loan shorter than six months.

"This suggests that increases in the OCR are likely to affect borrowers more quickly than during the previous tightening cycle," the MPS said.


See a history of the OCR here.