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RBNZ keeps OCR on hold for now, warns higher kiwi may warrant lower rates

Reserve Bank governor Graeme Wheeler left the OCR at 2.75 percent, as expected.

Paul McBeth
Thu, 29 Oct 2015

Reserve Bank governor Graeme Wheeler kept the official cash rate unchanged, while reiterating another cut is likely and warning a recent gain in the kiwi dollar could restrain inflation, adding to the case for a lower interest rate path.

Mr Wheeler left the OCR at 2.75%, as expected, having cut the benchmark rate three times this year to stoke activity in a softening economy and lift inflation, which has been below the bank's target band of 1-3% since September last year.

"To ensure that future average CPI inflation settles near the middle of the target range, some further reduction in the OCR seems likely," Mr Wheeler says. 

"This will continue to depend on the emerging flow of economic data. It is appropriate at present to watch and wait.

"The exchange rate has been moving higher since September, which could, if sustained, dampen tradables sector activity and medium-term inflation," he says. "This will require a lower interest rate path than would otherwise be the case."

The New Zealand dollar fell as low as 66.18USc, from 66.58c immediately before announcement and rebounding to 66.67c. The trade-weighted index was at 72.38 from 72.35.

Earlier this month Mr Wheeler said he was likely to cut interest rates again, and indicating he had another quarter-point reduction up his sleeve. 

Still, he has to balance that against a hot Auckland housing market that shows little sign of abating without a substantial increase in supply, while also retaining enough ammunition to respond to a global downturn weighing on New Zealand.

Last month, ructions in global financial markets prompted the Federal Reserve to take a more cautious approach when assessing when it should start raising interest rates, and that boosted the kiwi dollar after the currency's steep drop earlier this year.

Mr Wheeler says the recent gains in the currency could dampen tradables sector activity if they're sustained, reducing imported inflation, which made up for stalled domestic price increases in the September quarter.

If that seeped into medium-term inflation, it "would require a lower interest rate path than would otherwise be the case," he says.

In its September monetary policy statement, the Reserve Bank lowered its forecast track for the 90-day bank bill rate, often seen as a proxy for the OCR, by about half a percentage point across the projected horizon. It expects the rate to fall to 2.6% by September next year from 3% in the current quarter.

Today's meeting by the Federal Open Market Committee may reduce some demand for the kiwi after the US policymakers dropped their reference to global markets when keeping the fed funds rate between zero and 0.25 percent, a move interpreted as keeping alive a possible hike in December.

In a note before the RBNZ release, ANZ Bank New Zealand senior economist Philip Borkin and senior FX strategist Sam Tuck say they expected monetary policy to be more closely tied with the currency.

"In that way, the Fed's announcement this morning was highly relevant," they say. "It is of course too close to directly influence the RBNZ's thinking for the decision today, but the longer normalisation gets delayed (and others consider additional stimulus, with Sweden announcing more QE overnight), the longer the NZD could diverge from domestic fundamentals, increasing the need of a more aggressive RBNZ response."

The prospect of increasing money printing programmes in Europe and Japan will continue to boost the allure of the kiwi dollar on other currency cross-rates, with New Zealand's relatively strong economic outlook and positive interest rates.

Mr Wheeler says annual CPI inflation is still expected to return to within the target band early next year as the slump in petrol prices drops out of the data set's calculation, and the weaker currency.

New Zealand's services sector and tourism activity is still robust, despite weaker dairy prices crimping farmers' incomes, and Mr Wheeler says economic expansion is likely to spur a pick-up in non-tradables inflation despite an increasing labour market limiting wage growth.

Government data earlier this month showed non-tradables inflation was zero in the September quarter, slowing the annual pace to 1.5%, its smallest increase since December 2001.

New housing continued to be one of the main upward contributors to inflation, rising an annual 5.5% in the September quarter, and Mr Wheeler says Auckland house price inflation remains strong and is a risk to financial stability.

"While residential building is accelerating, it will take some time to correct the supply shortfall," he says.

The Reserve Bank's new restrictions on high loan-to-value ratio loans to residential property investors comes into effect next week, while the government's more stringent enforcement of taxing speculators' capital gains began this month.



Paul McBeth
Thu, 29 Oct 2015
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RBNZ keeps OCR on hold for now, warns higher kiwi may warrant lower rates