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Bollard holds OCR at 2.5%, pushes out timing of rates hikes amid global uncertainty

Thursday 8th December 2011

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Reserve Bank Governor Alan Bollard held the official cash rate at 2.5 percent, as expected, and pushed out the timing of future rate hikes saying uncertainty in financial markets could force up funding costs for local lenders and is threatening to hinder New Zealand’s recovery.

“Given the current unusual degree of uncertainty around global conditions and the moderate pace of domestic demand, it remains prudent for now to keep the OCR on hold,” Bollard said in a statement. Elevated debt in Europe is threatening to cause a worldwide economic slowdown, and the “tightness in international markets means funding costs for New Zealand banks will increase to some degree over the coming year,” he said.

The Reserve Bank reined in its forecast track for the 90-day bank bill, often seen as a proxy for the OCR, and said “monetary policy is projected to remain supportive for some time.” The bank now sees the 90-day bank bill gradually rising through the second half of next year before settling at 4 percent in September 2013. That trims 30 basis points from the top of the forecast, and removes a sharp increase in the June quarter next year.

Bollard had already pushed out the prospect of rate hikes and trimmed the top of the forecast 90-day bank bill forecast in the September monetary policy statement.

Before the announcement, traders were betting Bollard will raise the OCR just 3 basis points over the coming year, according to the Overnight Index Swap curve.

“The weaker global environment and risk of further negative financial shocks has seen the RBNZ back away from its previous plans to remove its ‘emergency setting’ policy sooner, rather than later,” said Paul Bloxham, Australia New Zealand chief economist at HSBC, in a note before the announcement. “With the labour market a bit weaker than expected and inflation coming in below forecasts, the RBNZ is also likely to flag some domestic grounds to wait a bit longer and assess global risks.”

Bollard said core inflation has eased back, and underlying inflations sit within the bank’s target band of between 1 percent and 3 percent at about 2 percent. Wage inflation has remained contained with fewer settlements above 3 percent compared to 2008, though there’s also been a reduction in negative or zero wage changes in the past few years.

Inflation has remained in check through much of this year, with the consumer price index and producer price indices showing slower acceleration than expected. The spike in the CPI from last year’s GST hike has worked its way through, and underlying inflation has been stable at about 2.5 percent in the third quarter, according to government data.

Earlier this year, Bollard indicated he was keen to remove the extra stimulus he added in response to the February earthquake, though that was put on hold as financial markets tumbled after the United States’ credit rating was downgraded and the Euro-zone struggled to come to grips with the high level of debt among some of its members.

Markets are waiting for Friday’s European Union leaders’ summit in Brussels, where it’s expected the region’s policymakers will agree to a workable plan to integrate their economies and clamp down on government spending in a deal to address members’ elevated public debt.

The European turmoil prompted the Treasury to cut its growth forecast for the March 2013 year to 3 percent from 3.4 percent, though the government department is still more optimistic on the economy than the New Zealand Institute of Economic Research, which is picking 1.5 percent growth in calendar year 2012.

The Reserve Bank cut its growth forecasts with Europe’s woes weighing on New Zealand’s trading partners and as the Christchurch rebuild is delayed. The bank expects growth of 2 percent in the March 2012 year, down from a forecast 2.8 percent in the September statement, and 2013 expanding 2.9 percent, down from 3.1 percent.

Since the last monetary policy statement in September, New Zealand’s sovereign credit rating has been downgraded by Standard & Poor’s and Fitch Ratings due to the size of the country’s external debt, though Treasury the Reserve Bank are expecting household savings to improve as people use the record low interest rate to repay debt and improve their personal balance sheets.

Those downgrades had “little impact on bank funding conditions” though the Reserve Bank said a further credit rating cut could “elicit a more substantial market reaction.”

The National-led administration, which won a second term on Nov. 26, has promised to continue spending cuts as it looks to return the government books to surplus by 2015, and has agreed to implement a fiscal spending cap as part of its governing agreement with the Act Party.

Last week, the government’s books showed a bigger than expected operating deficit of $3.36 billion in the four months ended Oct. 31. The shortfall was put down to a smaller than expected income tax take, though corporate tax revenue was running ahead of forecast.

In November, a three-month slide in business confidence was arrested according to the National Bank Business Outlook as companies shook off fears the local economy will get caught up in a global downturn.

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