RBNZ says rate cut seems likely as strong kiwi softens inflation outlook

Thursday 21st July 2016

The Reserve Bank will likely cut interest rates further as a persistently strong kiwi dollar makes it difficult for the bank to meet its inflation target, it said. The local currency fell.

In an out-of-schedule economic update, the Reserve Bank said it's struggling to meet its inflation objective of keeping the annual consumers price index between 1 percent and 3 percent with the New Zealand dollar 6 percent above expectations on a trade-weighted basis. The kiwi dropped to 69.89 US cents from 70.18 cents immediately before the release, and the trade-weighted index fell to 75.08 from 75.40. New Zealand two-year swap rates fell five basis points to 2.02 percent.

"At this stage, it seems likely that further policy easing will be required to ensure that future average inflation settles near the middle of the target range," it said in a statement. "We will continue to watch closely the emerging economic data."

The Reserve Bank has been reluctant to cut the official cash rate too far for fear of further inflaming a housing market that's threatening financial stability in a world where rates are near zero, making New Zealand assets offer better returns and stoking demand for the currency. In turn, that has kept a lid on imported inflation, and data this week showed the CPI has been below the bank's target band for seven quarters.

The central bank today said the currency is "notably higher" than in the alternative scenario presented in the June monetary policy statement, which would warrant more interest rate cuts, although it refrained from calling the kiwi unsustainably or unjustifiably high, criteria for it to intervene in foreign exchange markets.

"The high exchange rate is adding further pressure to the dairy and manufacturing sectors, and together with weak global inflation, is holding down tradable goods inflation," it said. "This makes it difficult for the bank to meet its inflation objective. A decline in the exchange rate is needed."

The bank also said house price inflation remains excessive and has become more broad-based, heightening fears about its threat to financial stability. The RBNZ this week signalled plans to extend loan-to-value ratio restrictions on home loans in an effort to cool the market, and Westpac Banking Corp yesterday said it would abide by the proposed limits immediately.

BusinessDesk.co.nz

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