RBNZ keeps OCR at 3.5%, signals slower pace of future hikes; kiwi drops

UPDATED 9am: Reserve Bank governor Graeme Wheeler kept the official cash rate at 3.5 percent and signalled he won't be as aggressive with future rate hikes as previously thought as inflation remains tamer than expected. The kiwi dollar fell to a seven-month low.

Wheeler kept the key rate unchanged, as expected, saying the economy was adjusting to the bank's rate hikes earlier this year, though risks still remained as to how much strong net migration will impact on housing, and the extent to which construction activity spills over into broader inflation.

“CPI inflation remains moderate, reflecting subdued wage increases, well-anchored inflation expectations, weak global inflation and the high New Zealand dollar,” Wheeler said in a statement. “In light of these uncertainties, and in order to better assess the moderating effects of the recent policy tightening and export price reductions, it is prudent to undertake a period of monitoring and assessment before considering further policy adjustment.”

Still, Wheeler said more rate hikes will be needed "to keep future average inflation near the 2 percent target mid-point and ensure that the economic expansion can be sustained."

The  New Zealand dollar fell below 82 US cents after the statement from 82.15 cents immediately before. The trade-weighted index dropped to 78.49 from 78.65.

In July, Wheeler signalled a pause in the bank’s current tightening cycle, saying the bank needed to take "some time" for “a period of assessment” was needed to gauge the impact of the four rate hikes this year. The market has pared back expectations for Wheeler to raise the key rate again this year as global commodity prices fall from their earlier highs, and as consumer prices rise at a tamer pace than anticipated.

The Reserve Bank cut the forecast track for the 90-day bank bill rate, often seen as a proxy for the OCR, by about 50 basis points over the projected horizon, with the rate rising to 3.9 by March next year and 4.8 percent by the middle of 2017. In the June monetary policy statement, it had seen rates rising to 4.3 percent by March 2015 and 5.3 percent by June 2017.

The central bank said there are signs the rate hikes have started having the desired effect of slowing growth in demand and keeping inflation in check, and it will monitor how the housing market is responding to policy changes and increased net migration, the impact of capacity pressures on inflation, business and household inflation expectations, and how the exchange rate is responding to falling export prices.

The September monetary policy statement projects a lower pace of inflation through to the end of 2015, and the bank said it's closely watching "how the housing market and domestic demand are developing, how capacity pressure is passing into inflation, and how the exchange rate will respond o falling export prices."

New Zealand consumer prices rose at an annual pace of 1.6 percent in the second quarter, just missing analyst forecasts and in line with the central bank’s expectations. Falling food prices in July firmed up analysts expectations the bank will hold off raising interest rates again this year.

Wheeler continued to jawbone the kiwi dollar down, calling the exchange rate's strength "unjustified and unsustainable" and that the bank expects "further significant depreciation, which should be reinforced as monetary policy in the US begins to normalise."  However, the kiwi is expected to remain relatively strong and a "headwind" for exporters and import-competing industries.

In July Wheeler ramped up his rhetoric in talking down the kiwi, calling it “unjustified”, a requirement of the bank’s policy to intervene in foreign exchange markets, and earlier this month traders speculated the bank may have been active in the market.

The Reserve Bank trimmed its projection for the trade-weighted index by 100 basis points, seeing it fall to an average 78.4 over the December quarter and dropping to 75.8 by the end of next year. It had previously seen the TWI holding at 79 through the remainder of the year, before falling to 76.9 in 2015 and the gauge of the currency was xx at 8am in Wellington.

Wheeler said the economy continues to be supported by increased building activity, consumer spending and business investment, though that will likely moderate due to recent drops in commodity prices and higher interest rates.

The economy is expected to grow at an annual pace of 3.7 percent in calendar 2014, the same pace Wheeler said in the July review, with the official forecast for gross domestic product growth of 3.6 percent in the March 2015 year, up from 3.5 percent in the June MPS.

(BusinessDesk)