Reserve Bank leaves OCR - dollar jumps

Reserve Bank governor Graeme Wheeler kept the official cash rate at 2.25 percent, in a decision traders had said could go either way, while predicting inflation will pick up as the slump in oil prices washes out of the data and capacity pressures start to build in the economy. The kiwi dollar jumped more than three-quarters of a US cent.

"We expect inflation to strengthen as the effects of low oil prices drop out and as capacity pressures gradually build," Wheeler said in a statement. "Monetary policy will continue to be accommodative. Further policy easing may be required to ensure that future average inflation settles near the middle of the target range."

Traders had put a 52 percent chance of Wheeler holding rates unchanged at today's review, whereas most local economists were picking it to stay unchanged. The kiwi jumped to 69.15 US cents from 68.34 cents immediately before the statement.

Wheeler has struggled to spur domestic inflation as the resilience of the kiwi dollar and cheap oil keep a lid on prices while being mindful of the impact of low borrowing costs on a buoyant property market.

Today Wheeler said the kiwi was "higher than appropriate" given the drop in New Zealand's commodity export prices, and that "a lower New Zealand dollar is desirable to boost tradables inflation and assist the tradables sector". He also acknowledged there were "some indications that house price inflation in Auckland may be picking up."

Last month Wheeler cut the benchmark rate to a record low to try to prevent weak inflation from embedding into wage and price setting behaviour. That surprised economists after Wheeler had earlier said he was able to look through price shocks, calling the focus on the consumers price index a "mechanistic approach".

Inflation is tracking at a 0.4 percent annual pace, below the 1 percent-to-3 percent target band, and the Reserve Bank doesn't see it moving back within the range until December this year. Still, an increasing number of firms surveyed in the New Zealand Institute of Economic Research said they intended to raise prices this year, something they've struggled to do in the past.

Wheeler said imports and cheap fuel were keeping headline inflation low, but that annual core inflation was within the bank's target, and that long-term inflation expectations were "well-anchored" at 2 percent. Still, short-term inflation expectations had gone through a "material decline", something the bank had previously noted, he said.

The local economy was still being supported by strong inward migration, construction, tourism and low interest rates, and while dairy prices had increased they were still below breakeven levels for farmers, Wheeler said.

Further complicating matters for Wheeler is the continuation of extraordinary monetary policy among the major central banks, with European and Japanese authorities persisting with money printing programmes, and the US still reluctant to raise rates. The Federal Reserve today kept the federal funds rate at between 0.25 percent and 0.5 percent, and reaffirmed its path to higher rates was a gradual one.

"Monetary conditions are extremely accommodative internationally, with considerable quantitative easing and negative policy rates in some countries," Wheeler said. "Financial market volatility has eased in recent weeks, but markets continue to watch the policy settings of major central banks."