RBNZ’s Wheeler says future rate hikes to come at 'later stage', keeps OCR unchanged

Thursday 11th December 2014

Reserve Bank governor Graeme Wheeler kept the official cash rate at 3.5 percent, saying any more rate hikes will be at a later stage as the central bank pulled back its track for future increases as tepid inflation provides scope to let the economy grow rapidly for longer. The New Zealand dollar jumped.

“Modest inflation pressures suggest the expansion can be sustained for longer than previously expected with a more gradual increase in interest rates,” Wheeler said in today's monetary policy statement. “Some further increase in the OCR is expected to be required at a later stage.”

Wheeler left the OCR unchanged, as expected, and trimmed the forecast track of the 90 day bank bill rate, often seen as a proxy for the cash rate, by 30 basis points, adding to the 0.5 of a percentage reduction by which the bank lowered its expectations in September. The rate is seen rising to 3.9 percent in September next year, and 4.5 percent by the end of 2017. It had previously seen the rate rising to 3.9 percent by March next year and 4.8 percent by the middle of 2017.

That's broadly in line with Westpac Banking Corp market strategist Imre Speizer's expectations, who said in a note before the release that a 30 basis point reduction in the forward track was his central forecast, and would likely have little impact on currency and swap rate markets.

The pace and timing of future hikes will depend on how the economy has responded to the 100 basis points of increases earlier this year, with three important considerations being how pricing decisions interact with capacity pressures and inflation, how house price inflation develops and how lower dairy incomes affect spending, the bank said.

The New Zealand dollar rose as high as 78.01 US cents, from 76.85 cents immediately before the 9am statement. It was recently trading at 77.74 cents.

In July, Wheeler signalled a pause in the bank’s current tightening cycle, saying the bank needed to take "some time" as “a period of assessment” was needed to gauge the impact of the four rate hikes this year. At last month’s review he dropped the reference that "further tightening will be necessary to keep inflation near the 2 percent target."

The bank has been surprised by the country’s tepid pace of inflation, which slowed to an annual 1 percent rate in the September quarter as a resilient kiwi dollar continues to keep imports cheap, while increased construction activity in Christchurch and Auckland fails to spill over into broader consumer price rises.

Wheeler said the strong exchange rate, falling oil prices and more subdued non tradable inflation was the cause of soft inflation, and the bank expects that slow pace to persist through the first half of 2015 before creeping higher. Tradable inflation also faces a short term downside risk, with oil prices falling below the bank's assumed range when it set the forecasts for today's report.

"The falls in oil prices since the finalisation of the forecasts, and the potential for further falls over the remainder of 2014, pose downside risk to tradables inflation over the December and March quarters," the bank said.

Still, that modest pace of inflation means the country's economic growth can be sustained for longer as households lift consumption and the Canterbury rebuild and buoyant property markets stoke construction activity.

The Reserve Bank expects gross domestic product to have expanded 3.4 percent in the year to December, supported by building activity, high net migration and the flow on from last year's record dairy payout. Forecast growth of 3.5 percent in the March 2015 year is slightly below its September forecast, though the bank raised its expectations for GDP expansion in 2016 and 2017 to 3.1 percent in both years, having previously projected annual growth of 2.7 percent and 2.3 percent. .

Fonterra Cooperative Group yesterday cut its forecast payout to farmers, which economists estimate will reduce their income by more than $6 billion from last year, when they enjoyed a record payout.

Wheeler said the currency remained "unjustifiably and unsustainably high" and that the bank expects "a further significant depreciation," even after its recent weakness as global investors flock to the greenback in anticipation of the Federal Reserve moving away from its zero interest rate policy next year. The bank noted that while the trade-weighted index was largely unchanged in the quarter, there had been a divergence on the cross rates where the kiwi weakened against the greenback, while strengthening against the yen and Australian dollar.

The kiwi fell to a two and a half year low against the greenback earlier this week, though it has held up on the other cross-rates.

The Reserve Bank expects the trade weighted index to trade at an average 77.5 in the December quarter of this year falling to 74.8 by the end of 2015, having previously seen it fall to an average 78.4 over the December quarter and dropping to 75.8 by the end of next year.

BusinessDesk.co.nz

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