Wheeler holds OCR at 2.5%

A high exchange rate means inflation – and interest rates – will stay lower for longer.

That is the implied message in today's Reserve Bank decision to hold the official cash rate at 2.5%.
 
The decision itself was not unexpected – almost all the economists who follow the New Zealand economy expected a no change decision today.
 
But new Reserve Bank governor Graeme Wheeler, in his first full monetary policy statement, is forecasting lower inflation than previous expected, which in turn gives him room to keep the OCR lower for longer. 
 
The central bank cites four key factors in its outlook:
  • Continued strength in the New Zealand dollar.
  • A construction sector boost, partly but not exclusively driven by the Canterbury reconstruction. Subdued trading partner growth.
  • The government's commitment to hold government spending at current levels until 2014-15.
The Reserve Bank now expects a greater lift in activity in Canterbury than it did previously, but also a lift in nationwide residential investment, particularly in Auckland, as housing supply constraints have pushed up prices over the past year.
 
For this reason, the central bank is relatively relaxed about house price inflation risks.
 
"House price inflation is expected to moderate, with house prices already very high... It is unlikely that the current pick up in house price inflation will have the flow on impact to household spending than was seen through the mid-2000s."
 
Internationally, the economic outlook is subdued "but less threatening than was the case in September", the monetary policy statement, released with today's decision, says.
 
"While continued recovery depends on policy support, the risk of severe near term deterioration in the euro area appears to have decreased."
 
The outlook in the United States is also more upbeat.
 
A key part of today's statement is the outlook for the New Zealand dollar.
 
The trade weighted index, which measures the New Zealand dollar against a basket of currencies related to New Zealand's trading partners, has, until recently, had a long run average in of around 62-63 on an index basis, and rarely poked above 70.
 
It spiked briefly above 70 in the middle of the last year when the New Zealand dollar climbed to a record high against the US dollar and returned above 72 in the first quarter of this year – where it has stayed.
 
While the economy slowed over the second half of this year, this is likely to be a temporary slowdown.
 
After an unexpectedly good first six months – with GDP at 1.6% – the second half of 2012 probably only saw growth of around 0.6%.
 

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