Reserve Bank Governor Alan Bollard says there are signs the economy is improving and should start growing again by the end of the year.
But after deciding to keep the Official Cash Rate unchanged at 2.5 per cent this morning, Bollard also warned that any recovery would be fragile, and that unemployment might keep rising well into 2010.
His move to leave rates on hold was widely anticipated, and is the first time he has done so since early June 2008. In every one the last seven OCR announcements he has cut, twice by a massive 1.5 per cent.
In his statement issued this morning, Bollard said the economic outlook remained weak both in New Zealand and in other countries.
He also warned of the risk posed by the current strength of the New Zealand dollar.
"A stronger dollar at a time of weak global growth risks delaying or even reversing the projected increase in exports, putting the sustainability of recovery at risk," he said when announcing the OCR today.
Immediately after the OCR decision the NZ dollar rose from around US62.50c to US63.10 and around 10.30am got up around US63.40c.
But commenting after the announcement, Bollard said he did not think lowering the OCR would have had "terribly much" effect on the exchange rate.
Bollard said there were signs that international financial conditions were improving.
"We expect the New Zealand economy to begin growing again toward the end of this year but the recovery is likely to be slow and fragile. Many key economic indicators such as unemployment are projected to keep deteriorating well into 2010," he said.
"There remain some material downside risks to activity and inflation, but for the first time in some months we can also identify some clear upside opportunities for activity. One such area is a potential rebound in household spending and residential investment as a result of the rise in net immigration and the pick-up in the housing market."
Bollard said that ultimately, however, the bank did not think such a spending rebound would prove sustainable "given the soft outlook for employment, wages and farm incomes and high levels of household debt".
On balance, said Bollard, the risks to activity remain "weighted to the downside".
"We have cut the OCR by a large amount over the year," he said. "We expect the effects to pass through to more borrowers over coming quarters as existing fixed-rate mortgages come up for re-pricing."
Although rising longer-term interest rates overseas were placing upward pressure on longer-term lending rates in New Zealand, there was room for further reductions in shorter-term lending rates.
Bollard said the low OCR and stimulatory fiscal policy were the main sources of support to the New Zealand economy at present.
"It is likely to be some time before the recovery becomes self-sustaining and monetary policy support can be withdrawn," he said. "We therefore consider it appropriate to continue to provide substantial monetary policy stimulus to the economy."
He said the OCR could still move "modestly lower" over the coming quarters.
The bank still expects to keep the OCR "at or below" its current 2.5 per cent through until "the latter part of 2010".
In its Monetary Policy Statement, the Reserve Bank did acknowledge that the cuts to the OCR during the past year had passed through more than in most countries to the interest rates faced by households and businesses.
"However, it appears as though the most recent reductions in the OCR have not been passed on to borrowers to the extent that we would have expected," the statement said.
"While there has been some increase in funding costs from higher retail deposit rates and longer term interest rates offshore, this does not appear to fully explain the relative lack of movement of interest rates at shorter terms."
ASB economist Jane Turner said today's announcement was "broadly as expected".
She said the Reserve Bank had "acknowledged signs of so-called green shoots, noting international economic activity is stabilising and international financial conditions are improving."
"While verbally the Reserve Bank has maintained its easing bias, their 90 day forecast does not actually incorporate another cut," said Turner. "The Reserve Bank may think it has done enough for now and the threshold for further cuts is now higher. The bank seems resigned to the fact the NZ dollar and longer-term rates are higher than would be ideal."
The ASB economists still think there is a good chance of further rate cuts, but they have pushed the timing of the cuts back - with 25 basis point cuts in September and October, taking the Official Cash Rate to 2 per cent.
Bollard's campaign to get the banks to cut their interest rates in line with the OCR cuts was joined by some Parliamentary allies this week.
The major banks were criticised in a report by Parliament's finance and expenditure committee, with MPs accusing them of failing to reduce mortgage rates, and protecting their profits, despite falling official interest rates.
In late April the Reserve Bank cut the rate by 50 basis points to its current record low of 2.5 percent.
NZHERALD STAFF/NZPA
Signs of improving economy, but recovery fragile - Bollard
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