Reserve Bank holds interest rate

Reserve Bank Governor Alan Bollard surprised nobody today when he left the Official Cash Rate (OCR) unchanged in the December quarter Monetary Policy Statement.

But Dr Bollard sided more towards Scrooge than Father Christmas in his outlook for interest rates.

Instead of a pattern of gradual rate relief starting next year, Dr Bollard stressed a further rate hike could not be ruled out.

This is despite the bank no longer expecting inflation to creep outside the 1-3 per cent target band -- as had been forecast in September -- and an economic slowdown being almost assured next year.

The bank is projecting the economy will expand by an impressive 5.2 per cent in calendar 2004 -- that is much stronger than the 4.65 per cent the bank forecast in September.

"The tightening in monetary policy over the past year currently looks sufficient to keep medium-term inflation pressures in check," Dr Bollard said.

But with inflation expected to remain near the top of the target band there was "little headroom" to absorb further inflation pressures.

"If such pressures emerge, a further policy tightening cannot be ruled out.

"Further, the current outlook offers little scope for an easing in the foreseeable future," he said.

He said monetary policy was "on hold". Dr Bollard, as he has done at almost every set of forecasts this year, said the economy had continued to surprise on the upside.

The bank has pushed out the expected economic downturn but it is still expected in 2005.

GDP growth is projected to slow to 4.75 per cent by the March 2005 year and then to 2 per cent the following year.

Dr Bollard said the easing in house sales and building and migration had occurred in line with expectations. Reinforcing the outlook for a downturn was softer world growth and the constraining effects of a strong New Zealand dollar.

Export performance is likely to be worse than projected in September.

"We consider the turning point in the business cycle is near," he said.

But there was a risk that the current momentum in household demand -- from home owners borrowing on the back of higher house prices -- continued longer than expected. As well, rising wage and salary pressures as a result of a tight labour market added to inflation pressures, he said.

Hence, the threat to hike rates rather than ease.

Inflation is seen at 2.75 per cent in the March 2005 year, rising to 3 per cent in 2006 before easing back to 2.75 per cent in 2007.

Dr Bollard said the counter-balancing effects of this year's six rate hikes and the stronger currency had still to work their way through the economy. The bank believes recent moves by private sector lenders to lower mortgage rates were temporary "as there is little to suggest that current margins between wholesale and retail rates are sustainable".

The bank's projections assume 90-day bank bill yields will average 6.75 per cent all through 2005, compared with 6.5 per cent in the second half of 2004.

Today's much more "hawkish" (tougher) than expected Monetary Policy Statement is likely to give a further boost to the kiwi dollar, which this week hit 16-year highs of US72.68c.

In late October, Dr Bollard surprised financial markets with a "dovish" statement that suggested the tightening cycle had run its course.

Today's flip-flop, suggesting interest rates -- the highest in the developed world -- will stay high, or go higher, is likely to see more cash pouring into New Zealand, pushing the currency higher.

The RB points out in documents that foreigners are buying New Zealand dollar bonds at the rate of more than $10 billion a year. That's even bigger than New Zealand's current account deficit, which is forecast to swell to 6.5 per cent of GDP in 2007.

Westpac chief economist Brendan O'Donovan said the MPS was a turnaround from the Reserve Bank's October statement, but held no surprises.

"This should have been the tone of the October statement. They have gone back to the halfway between the hawkish September and a fairly dovish October," he said.

He said after the last statement the market had priced in the likelihood of interest rate cuts, which would now be taken out.

"With the tightening bias being reintroduced the currency will be very well supported," he said.

The New Zealand dollar bounced after the release of the MPS and at 9.30am was at US71.35c, up from US70.45c at its 8.30am open today.

- NZPA