Bollard leaves OCR unchanged but surpises with hawkish tone

By Jenny Ruth

Thursday 9th December 2004

As expected, Reserve Bank governor Alan Bollard left the official cash rate (OCR) unchanged at 6.5%, although he says further increases can't be ruled out and that there is little scope to cut rates in the foreseeable future.

"There are no surprises in the decision but there's a few surprises in the tenor," says Cameron Bagrie, an economist at ANZ National Bank. "They've come out a lot more hawkish than the market expected. It's lit a fire under the currency."

Market reaction was strong, particularly in the New Zealand dollar which climbed half a US cent to 71.30 cents and shot through 94 Australian cents within half an hour of the statement.

Wholesale interest rates rose about five basis points across the curve from short to long-term rates. Previously, while economists had been talking about a rate cut at the end of next year, the market had been pricing in a rate cut in the first half of 2005.

Bagrie says monetary policy is very much a roller coaster with today's statement reversing the more dovish tone and neutral stance at the last OCR review in late October.

Brendan O'Donovan, chief economist at Westpac Bank, shares those sentiments. "They've done an averaging of the September and October statements - it's very much what the October statement should have delivered but didn't. Rather than saying, we're done and dusted, they've given themselves back some flexibility," O'Donovan says.

The central bank has also changed its view of the outlook for inflation and is now talking of two-way risks. On the upside, it sees a risk that the current momentum in household demand will hold up longer than expected but that the possibility of "more exaggerated movements" in the US dollar and US interest rates could lead to weaker exports and therefore less inflation pressure.

O'Donovan says that's in sharp contrast to the last monetary policy statement in September when the Reserve Bank talked only of the risks inflation may turn out stronger than expected.

Bagrie expects the currency will rise back to 72 or 73 US cents over the next few days. "I think international investors will be surprised. We're likely to see quite strong offshore interest in the next 24 to 48 hours."

And the higher the New Zealand dollar rises, the less likely it will be that Bollard will raise rates further, he says.

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