Reserve Bank to keep OCR unchanged though hikes flicker on horizon

Alan Bollard. File photo / NZPA

The Reserve Bank of New Zealand is expected to keep its benchmark interest rate at a record low next week in the face of benign inflation, though hints of an increase are starting to flicker on the horizon.

Governor Alan Bollard will keep the official cash rate at 2.5 per cent when he releases the quarterly monetary policy statement, according to all 15 economists in a Reuters survey.

Next week's statement will be the first full update of the central bank's forecasts since December and in the ensuing three months government figures have shown inflation pressures fell in the fourth quarter. The trade-weighted index has unexpectedly climbed to 73.87, keeping a lid on imported inflation. The RBNZ's December forecast was for the TWI to average 67 in the first three months of 2012.

Companies have trimmed their expectations for inflation over the next two years, cutting their one-year expectation to 2.24 per cent, from 2.7 per cent before Christmas, and their two-year expectation to 2.2 per cent from 2.82 per cent.

The inflation picture looks much friendlier than it did a few months ago and an unexpected surge in the exchange rate has further mitigated the need for policy tightening any time soon," said Dominick Stephens, chief economist at Westpac, in a preview of next week's MPS. He expects Bollard to signal a return to rate hikes "no earlier than December" this year.

Traders have resumed bets on a hike to the OCR, according to the Overnight Index Swap curve. This month they have built in 23 basis points of increases to the OCR over the next 12 months, implying one quarter-point increase to 2.75 per cent by March 2012.

One of the big unknowns is the rebuild of earthquake-shattered Christchurch - a herculean task that's been delayed by further quakes and slow progress on some insurance claims. The delays mean there's a vast pipeline of spending on everything from building materials and tradesmen, to carpets and crockery.

The delays have hurt earnings at companies including Fletcher Building, which has the mandate to oversee rebuilding in the city.

The "high degree of uncertainty" over Canterbury's rebuild has helped keep the OCR unchanged, Bollard said in a Jan. 27 speech in Christchurch, adding that he expects work won't begin in earnest until 2013.

But he also warned that when work does get underway "spare capacity and labour will be absorbed rapidly, and inflation pressures will pick up from current low levels."

"We will need to keep monitoring this to judge whether the level of the OCR continues to be appropriate," he said.

The Reserve Bank "will be focussing a lot of attention on ensuring that this pressure does not spill over into the wider economy's wage and price-setting behaviour," said Nick Tuffley, chief economist at ASB, in his OCR preview.

ASB sees the OCR on hold until December though Tuffley said the tone of next week's MPS "is likely to be a little more upbeat", mainly reflecting an improved global outlook. The tightening cycle is likely to see the OCR peak at 4 per cent, he said.

That would leave New Zealand's benchmark rate lower than the Reserve Bank of Australia's, at 4.25 per cent, though across the Tasman, traders are betting on 43 basis points of cuts to the central bank rate over the next 12 months.

Bollard is likely to point to a more benign global situation, given euro-zone leaders have all but signed off on extending a further round of financial aid to Greece, while flooding the banking system with as much cash as lenders can digest.

"While Europe is certainly not out of the woods yet, the chances of a catastrophic deterioration in European and global growth appear to be receding," Tuffley said.

Improving conditions in Europe may also provide some relief for bank funding costs as credit markets become easier, which could help mitigate increases in New Zealand retail rates.