Slow recovery expected to keep rates on hold

Darren Gibbs. Photo / Paul Estcourt

The financial market sees it as a near certainty the Reserve Bank will leave the official cash rate on hold when it reviews it on Thursday, and expects another downbeat assessment of the near-term outlook for the economy.

Over the second half of last year, as the pace of recovery continued to disappoint, the bank progressively hauled its projected interest rate track lower.

Its December statement conceded that continued caution by businesses and households suggested low interest rates were having a less stimulatory effect that they would have in the past.

"There's been one major piece of news on the economy since the December statement, and it was a shocker," Westpac economist Michael Gordon said.

"September quarter GDP fell by 0.2 per cent, against market and Reserve Bank forecasts of a 0.3 per cent rise, and the June quarter was also revised down slightly to a 0.1 per cent gain."

Deutsche Bank chief economist Darren Gibbs said it was the second successive quarter in which the central bank had significantly overestimated the economy's momentum and it implied a significant and unexpected increase in spare productive capacity.

And while he thinks the economy did expand again during the December quarter, Gibbs said recent data on consumer spending, construction, trade and the weather suggested it was less than the 0.4 per cent the bank forecast.

However, developments in trading partner economies continue to be mostly favourable, Gibbs said, with signs of strengthening growth in the United States, solid growth in the core European countries and still strong growth in Australia and most of Asia.

"Those developments continue to underpin a positive trend for New Zealand's key export commodity prices, which have continued to make new highs in recent months."

Gordon said there were positive signs recently including improvements in business and consumer confidence in January, a rise in job advertisements, a return to growth in the manufacturing sector, as well as record highs for export commodity prices.

"But the weaker starting point for the economy will trump all of these factors in the Reserve Bank's thinking," he said. "Inflation pressures are likely to appear quite benign through 2011."

That might seem odd when annual inflation would be above 4 per cent for most of the year, and could peak above 5 per cent, he said.

"But much of that reflects a one-off price spike due to the GST increase and other government policy changes. Another part of it is higher fuel prices, and global trends suggest that food price inflation will also need to be watched closely in 2011. But setting these factors aside, this is not an economy that's generating a lot of inflation under its own steam right now."

Spending by households remains torpid. Electronic card transactions in December were down on November apart for the automotive sector. The Real Estate Institute reported turnover and prices last month were down on November and on December 2009.

ASB economist Christina Leung said patchy demand was keeping businesses cautious. Bank lending to the business sector is down 6 per cent on a year ago and down 11 per cent on two years ago.

Leung said the three key areas the Reserve Bank would be looking for evidence of recovery were the housing market, business investment and business credit.

"We believe it may take until mid-2011 at the earliest for these three factors to show convincing signs of recovery and as a result we now see September as the earliest the Reserve Bank will resume lifting rates."