RBNZ keeps rates on hold, little change in outlook

Reserve Bank Governor Adrian Orr announced the Official Cash Rate today. Photo/File.

The Reserve Bank has opted for a "steady as she goes" approach to monetary policy in keeping its official cash rate (OCR) on hold at the historical low point of 1.75 per cent.

In today's release, the Reserve Bank said it expected to keep the OCR at this level through 2019 and into 2020 and that the next move could be up or down.

The bank's move was in stark contrast to the US Federal Reserve's decision to lift its federal funds rate to a range of 2.0 to 2.25 per cent, signalling that several more hikes are in store.

The differing stances of the two central banks has put another nail in the coffin of New Zealand dollar's reputation as a "carry" currency - when it once offered rates of interest that were far more attractive relative to those available in other countries.

The Reserve Bank's statement follows data from Stats NZ this month showed that the economy grew by 1.0 per cent in the June quarter, higher than market expectations of 0.8 per cent and double the central bank's own forecast.

"While GDP growth in the June quarter was stronger than we had anticipated, downside risks to the growth outlook remain," Reserve Bank Governor Adrian Orr said in a statement.

Phil Borkin, senior macro strategist at ANZ, said the Reserve Bank's stance would limit any gains in the Kiwi.

Interest rate differentials - the different interest rates that prevail in various countries - are an important driver for the foreign exchange markets.

"They work on expectations of those interest rate differentials and, at the moment, markets have priced in a 30 per cent chance of a cut by the Reserve Bank, and are priced for more hikes by the Fed," Borkin said.

"The issue is: Is there going to be something that changes that current situation? And for the near term, I don't think that's the case," he said.

Borkin said the currency, which last traded at US66.60c, appeared to be fairly priced from an interest rate differential perspective.

"If that data flow in New Zealand does start to deteriorate further, and the chance of a rate cut increases, then absolutely the New Zealand dollar will face some pressures on the back of that," he said. "But we need to see the evidence to determine whether that is going to play out or not."

ASB chief economist Nick Tuffley said he expected the bank to keep rates on hold and to eventually lift the OCR early in 2020.

"However, the risks through to mid-2019 are tilted to a lower OCR due to low levels of business confidence," he said in a commentary.

"Although the Reserve Bank will have been pleasantly surprised by the strength of second-quarter GDP, continued soggy business confidence will keep it wary about the growth performance for the rest of 2018 – particularly the tail end of the year," Tuffley said.

Today's central bank news means the Kiwi no longer rated as a "carry" currency, Mark Brooks, head of income at NZ Funds, said.

"New Zealand interest rates are low and, while the economy is robust, inflation remains subdued and it is not obviously overheating," Brooks said.

NZ Funds sees the impact of higher US interest rates coming through the currency rather than through domestic interest rates.

"In the past, New Zealand has had higher interest rates than the major world economies and this has encouraged investors to hold the New Zealand dollar," he said.

"Today the New Zealand dollar is a low yield currency, and this is a disincentive for investors and will keep the pressure on the NZ dollar," he said.

NZ Funds expects the NZ dollar will generally continue to struggle against US dollar over the next year.