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Reserve Bank leaves interest rates unchanged


Wednesday 20th November 2002

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Reserve Bank Governor Alan Bollard preserved his reputation as "Dr No Change" when he elected to leave New Zealand's official interest rate at 5.75 percent at this morning's quarterly review.

The new governor, in only his second outing since taking the reins from Don Brash in September, also flagged his intention to keep short term rates steady over the period ahead -- as the uncertain global outlook moderates local inflation pressures.

"The new Policy Targets Agreement (PTA) directs the bank to target future consumer price index inflation outcomes of 1 to 3 percent on average over the medium term," Dr Bollard said, referring to the monetary policy agreement he signed with the Government following his induction in September.

"Looking ahead, current policy settings appear consistent with that objective. In essence, strong domestic demand is expected to be offset by offshore developments, keeping inflation pressures in check."

The move marks a change from Dr Brash's hawkish approach and is a sign Dr Bollard is keen to leave his own signature on monetary policy.

In his former role as Treasury secretary, Dr Bollard is thought to have been frustrated by Brash's keenness to put rates up as soon as the economy looked like it was gaining a head of steam.

"The new PTA provides monetary policy with a little more flexibility in the way it responds to changing economic conditions. Our intention is to operate policy in a flexible manner to meet our obligations under the PTA," Dr Bollard said.

He added that in typical circumstances, the bank would give most of its attention to the outlook for inflation over the next three or more years.

"If the outlook for inflation over that period is inconsistent with the target range, then monetary policy will be adjusted.

"Our goal in making that adjustment will be to ensure that, in the absence of significant unforeseen events, inflation will be back within the target range in the latter half of that three year period."

Commenting on the current situation, Dr Bollard said that unlike most of our trading partners, the New Zealand economy has performed well in 2002.

"Activity has continued to benefit from the surge in export earnings over the past two years and from the recent rapid population growth. To date, weak global conditions have not had as large an impact on the local economy as we might have expected," he said.

Gross domestic product grew by 3.3 percent in the March 2002 year, and the Reserve Bank is picking growth will peak at 4.3 percent in March 2003 before easing to 2.5 percent in 2004 and 2005.

Under Dr Brash's leadership, the bank deemed growth of above 3 percent unsustainable without creating unacceptable inflation pressures, and generally responded by hosing it down by raising interest rates.

Dr Bollard confirmed a change of tack today, saying that while strong domestic demand and labour pressures have led to higher prices in some domestic-based industries, the soft international economy, falling commodity prices, and the rising exchange rate have kept inflation steady -- albeit at a relatively high level.

The bank forecast inflation, as measured by the Consumer Price Index (CPI), to peak at 2.6 percent for the December quarter -- at the top end of its target band -- before easing to 2.3 percent in March, 2003. Looking ahead, Dr Bollard expects economic growth to slow over the coming year in response to international market conditions and a moderating of the demand pressures associated with strong population growth.

"The rise in the exchange rate over recent months, if sustained, will also put downward pressure on inflation over the next few quarters and exert some braking effect on activity and inflation further out."

The New Zealand dollar briefly touched US50.20c on Friday -- a 2-1/2-year high.

Forex dealers expect today's "no change" decision to propel the unit even higher, as the yield differential between New Zealand and its major trading partners widens. The kiwi dollar did rise a little after the announcement -- from US49.58 to US49.65c.

Australia left its key interest rate unchanged at 4.75 percent earlier this month, while in the United States the Federal Funds rate is at 1.25 percent. The trade-weighted-index (TWI) measuring the Kiwi against a basket of major currencies was at 56.50 this morning. The Reserve Bank forecast the TWI will average out at 55 next year, rising to 56.75 in 2004 and 57 in 2005.

On the money market, 90-day bills rose a couple of pips to 5.91 percent following today's announcement, which was widely-expected. A Reuters poll last week showed private sector forecasts of no change in the Official Cash Rate (OCR) -- which acts as a benchmark for home loans and business lending -- had firmed to 84 percent from the previous 77 percent.

Today's move won't win Dr Bollard friends in all quarters, however. Some, like the Council of Trade Unions (CTU) had called for interest rates to fall.

"The economic outlook for next year is being influenced by a continuing slide in global economic conditions and with widening deflationary pressures, falling NZ commodity prices, a rising NZ to US dollar exchange rate, and the prospect of a drought," CTU economist Peter Conway said.

"These factors put together mean that it is unwise to have the OCR sitting at 5.75 percent, which is much higher than our trading partners."

The tone of Dr Bollard's statement was more hawkish than expected and that helped send the New Zealand higher against both the US and Australian dollars.

The kiwi firmed to US49.75c from US49.68c just before the 9am announcement.

Against the Australian dollar it rose half a cent to A89.05c -- its highest level for four years.

BNZ chief dealer Mike Symonds said despite the stregthening of the US dollar, the kiwi had moved up against most other currencies.

He said it seemed New Zealand was in an enviable economic position compared with most countries' economies with the economy performing and the Reserve Bank with plenty of ammunition to move rates if needed, unlike in the US and Japan.

"New Zealand looks to be very well placed as we head into 2003."

Cameron Bagrie, economist at National Bank agreed the statement was more hawkish than what the market was set for.

"He's talking about domestic strength versus external weakness so it looks like the Reserve Bank is going to be in a holding pattern until your global weakness starts to manifest itself in the domestic indicators.

He said the central case was for the economy to have a "soft" landing next year.

Robin Clements, chief economist at UBS Warburg said it looked like interest rates would be on hold until well into next year.

"The fact that they appear to be saying "no change" for the foreseeable future, that's fair because you can go down either scenario as to whether you think things get that much worse on the global scene to require easing or the domestic economy wins over and you have to tighten.

"Most of us in the market have got no change at least until March, some a lot longer than that."

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