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FULL REPORT: Bollard keeps OCR at 2.5%, reiterates mid-year timing for rate hike

Thursday 11th March 2010

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Reserve Bank of New Zealand Governor Alan Bollard kept the official cash rate unchanged at 2.5%, as expected, and reiterated a mid-year start to rate hikes, saying the subdued pace of recovery will restrain inflation.

 “The relatively sluggish recovery predicted in recent statements continues to play out,” Bollard said at the release of the Monetary Policy Statement in Wellington.

“Households are still cautious, with house sales and credit growth remaining subdued. Business spending is weak despite much improved confidence.”  

All 17 economists in a Reuters survey correctly predicted Bollard would stand pat on interest rates today. Before today they were forecasting a 25 basis point hike in the OCR by June 30 and 1.25 percentage points of increases to 3.75% by the end of the year.

Today’s statement will likely keep that scenario intact. The recovery from last year’s recession has been more muted than many analysts had expected, with the jobless rate reaching a 17-year high, while building consents have tapered off and consumers pared spending on debit and credit cards, suggesting they’re still fretting about job security and the value of their homes.  

Consumer prices fell 0.2% in the fourth quarter 2009 and are projected to rise 0.3% in the first three months of 2010 and 0.9% in the June quarter, according to the central bank’s latest projections.  

That’s a stronger near-term track than the bank was predicting in its December MPS, when it had first-quarter CPI at just 0.1%.

Bollard said the amended Emissions Trading Scheme and increases in ACC charges will help drive up prices. 

He reiterated that ”fiscal consolidation” would help reduce “the work that monetary policy might otherwise need to do.” “Fiscal restraint beyond that described in Budget 2009 would be welcome and would help reduce the work that monetary policy might otherwise need to do,” he said. 

Still, a record-low OCR hasn’t provided as much stimulus to the economy as might have been expected because banks have faced higher funding costs, Bollard said. 

“We expect these costs to persist over the projection, reducing the extent of future increases in the OCR.” 

The Reserve Bank estimates the marginal cost of bank funding has increased to about 150 basis points above the OCR from as little as 20-30 basis points before the financial crisis.  

The projected track of the 90-day bank bill rate is almost unchanged from the December MPS, at 2.9% average in the June quarter, rising to 3.6% in the final three months of 2010, from an earlier prediction of 3.5%. 

Bollard is likely to get more bang for his buck when he does start removing monetary stimulus, with a greater portion of homeowners on floating mortgages or terms of less than 12 months than when he was last embarking on a tightening cycle five years ago. 

“Because of increased bank funding costs, a shortening in mortgage duration and a positively sloped yield curve, we expect this tightening to have quite a powerful and relatively immediate impact on the economy,” he said.  

The MPS notes that recent strength in house price inflation “appears to have been temporary,” with activity in the housing market abating.

House prices remain high relative to incomes and affordability has been further hampered by rising mortgage rates. 

The bank lifted its forecast for gross domestic product and now expects the economy grew 0.9% in the first quarter and will expand 1.1% in the second.

Three months ago its estimates were 0.8% and 0.9% respectively. Still, growth tails off again by the fourth quarter to a pace of 1%, down from a previous estimate of 1.1%. New Zealand companies are also anticipating a gradual recovery.

Business confidence has climbed to a 10-year high and data this week showed the terms of trade improved in the final quarter of 2009.  

“Growth will gather momentum this year,” Robin Clements, senior economist at UBS New Zealand, said before today’s statement.  

Keeping the OCR at 2.5% maintains Australia’s rate advantage at 1.5 percentage points after the Reserve Bank of Australia extended its tightening last week by lifting its cash rate to 4%.

The rate gap, coupled with data showing Australia’s economy is on a tear, has helped drive the kiwi dollar to a 10-year low against its Australian counterpart. 

The trade-weighted index of the kiwi dollar is projected to hold at around current levels of 64.5 through 2010 before declining next year, as trading partner activity picks up and global interest rates rise, to reach 61.9 in the fourth quarter of 2011. 

Activity of trading partners has recovered “a little faster than expected,” notably in China, Australia and emerging Asia, Bollard said.

Activity is “much more muted in other trading partners” and risks around the global outlook have increased, though not to the levels seen at the height of the crisis, he said.  

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