Reserve Bank governor Alan Bollard this morning cut the official cash rate to 2.5% from 3%. But the cut, which was widely anticipated following the Christchurch earthquake last month, may be a relatively short-lived one.
Reserve Bank governor Alan Bollard this morning cut the official cash rate to 2.5% from 3%. But the cut, which was widely anticipated following the Christchurch earthquake last month, may be a relatively short-lived one.
The Reserve Bank’s forecasts accompanying the decision suggest the economic recovery has been pushed back to the latter part of 2011 but also highlight increased inflationary pressures compared to the previous outlook.
“It seems quite possible that GDP will contract in the March quarter,” says the Monetary Policy Statement which accompanied Dr Bollard’s decision.
Growth is now not expected to pick up until the second half of the year.
“Even before the earthquake, GDP growth was much weaker than expected through the second half of 2010. Households have continued to be cautious, with retail spending volumes and residential investment both declining.”
Although the terms of trade have been high, with both farmers and the manufacturing sector reaping the benefits, this has not flowed through into increased economic activity.
“The export sector has benefited from very high commodity prices. However, farmers have focused on repaying debt rather than increasing spending.”
“Even the manufacturing sector, for which domestic sales have contracted substantially, continues to record export growth.”
On the inflation front, the Reserve Bank says there are a number of pressures pushing inflation – or at least price inflation – upward.
As well as international developments pushing fuel and food prices extremely high, the earthquake will also mean rent increases and hikes in insurance premiums.
The most significant inflationary impact of the earthquake though will be an anticipated construction boom rebuilding Christchurch and the wider Canterbury area affected by the earlier quake.
The Reserve Bank expects the rebuild to take up to a decade and because of this the inflationary pressures “could prove persistent.”
“Given monetary policy’s focus on the medium term, trend in inflation, it would therefore be inappropriate, all else being equal, for monetary policy to be stimulatory during reconstruction.
That points to an earlier rather than later lift in the official cash rate.
However, Dr Bollard’s comments on when he is likely to life the official cash rate again were deliberately opaque.
“Future monetary policy adjustments will be guided by emerging economic data. We expect that the current monetary policy accommodation will need to be removed once the rebuilding phase materialises. This will take some time.
“For now we have acted pre-emptively in reducing the OCR to lessen the economic impact of the earthquake and guard against the risk of this impact becoming especially severe.”
The high prevalence of floating mortgages at present means the Reserve Bank can pre-emptively ease the official cash rate now knowing that the reduction in retail interest rates can be reversed quite quickly when the economy begins to recover, he said.
