Governor predicts strengthening economy ahead

Reserve Bank governor Graeme Wheeler

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Reserve Bank governor Graeme Wheeler today kept the official cash rate at 2.5% but says he is watching house prices and credit growth very closely.

"The bank does not want to see financial stability or inflation risks accentuated by housing demand getting too far ahead of supply," her says.

The mention of "financial stability" in that comment is significant as it is not usually discussed in monetary policy releases.

The central bank is putting together a batch of regulatory tools under its financial stability responsibilities which, although they do not directly concern monetary policy, will have a major practical effect on interest rates.

Two are already being implemented: the core funding ratio, requiring banks to hold a higher level of longer term funds than previously, has been gradually introduced over the past three years. A second, the counter cyclical capital buffer, starts from the end of this year.

Loan-to-value ratios and other more targeted methods to focus on areas of the economy showing a degree of credit expansion which  threatens financial stability – such as the housing market – are also under consideration.

All will have the effect of putting up retail interest rates and/or reducing the amount banks lend, without the Reserve Bank having to put the official cash rate up.

On that front, Mr Wheeler gave no further hints as to his next OCR move, repeating his previous line that "on balance, it remains appropriate for the OCR to be held at 2.5%".

He is, however, more optimistic about the economy than he was at the time of his last update on December 6 last year.

"Global growth is set to recover in 2013 with economic indicators improving in many of our trading partners.

"Domestically, recent data on business confidence and construction activity suggest GDP growth is recovering from the softness seen through the middle of last year. The Canterbury rebuild is gathering momentum and its impact will be felt more broadly in incomes and domestic demand."

Inflation remains low, he says – and points out this mostly due to the benefit of the high exchange rate, which he describes as "over-valued."

"The high currency is directly suppressing inflation on traded goods and is undermining profitability in export and import competing industries.

"At the same time, the labour market remains weak and fiscal consolidation is dampening growth.

"Overall, we expect economic growth to strengthen over the coming year, reducing spare capacity and bringing inflation slowly back toward the 2% target midpoint."

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2 Comments & Questions

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Strengthening E. Conomyming, too.

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Good report, and fairly balanced

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