RBNZ hold rates at 2.5%, lowers growth forecasts

The decision this morning was unanimously expected by economists but the implications of the accompanying monetary policy statement is that there will be no change in the OCR for some time. 

The central bank's forecasts are now more downbeat:worsening global economic conditions have led the Reserve Bank shave nearly 1% off its growth forecasts for the next three years. 

GDP growth is now expected to total 8.3% over the next three years: back in September the Reserve Bank's forecast was for 9.1%. Volatility from the Eurozone and a "modest" downturn in the hitherto booming Asia-Pacific export markets, are all cited as reasons for a more restrained growth path. 

A "soft" domestic economy is the other main reason. 

Several factors are driving this: the almost daily news diet of economic crises in the north Atlantic economies is having an effect on consumer and - to a lesser extent, surprisingly - business sentiment. The noises of financial panic from offshore will also have a more tangible impact on retail interest rates. 

Bank funding costs are expected to rise over the coming year, regardless of what the Reserve Bank does with the official cash rate. 

"The current turmoil in financial markets has increased the premium that New Zealand banks pay for long-term wholesale funding," says the Reserve Bank's monetary policy statement. 

"While weak loan growth and continued deposit growth from increased saving will reduce the need for banks to borrow offshore, some funding scheduled to mature in 2012 will likely need to be rolled over.

"Assuming some leakage into higher domestic deposit rates, this implies that average bank funding costs will increase, and put upward pressures on the spread of mortgage rates relative to 90-day rates." 

Monetary policy will need to take account of such pressures, the statement says. 

That implies the OCR is likely to remain at present levels for quite some time. 

The overnight index swap (OIS) market has priced in no rate rise until around the fourth quarter next year, and has actually implicitly priced in a rate cut in the first few months of 2012, but no economist expects the Reserve Bank to do this. 

The weak loan growth and rise in bank deposits mentioned above is also having a contractionary impact on the domestic economy and is one other reason cited for the more restrained GDP outlook. 

A further factor is the government's budget track of minimal real increases in government spending for several years. 

As well as a less optimistic track for growth, the statement is also anticipates lower inflationary pressures and a lower track for the New Zealand dollar. 

On a trade weighted index (TWI) basis the currency is now expected to depreciate slowly over the next three years. This is a dramatic contrast to expectations at the time of the last statement in mid-September, which forecast the TWI to stay high until towards the end of next year, and even then only drop slowly. 

The TWI track now implies the New Zealand dollar has peaked and will gradually decline back to levels last seen in late 2009 over the next three years. 

Underlying consumer prices index (CPI) inflation is at around 2% and although the depreciation in the TWI will put more imported inflation pressure on the index it is still expected to hover at or around 2% over the forecast period.