Wheeler: high dollar, tight govt policy helping keep interest rates low

The high exchange rate and tight government fiscal policy mean the Reserve Bank can hold interest rates for longer.

That appears to be the implicit message in today's "no change" decision from bank governor Graeme Wheeler. As expected, he is keeping the official cash rate at 2.5%.

That was the only real "no surprise" part of today's announcement. As if to confound commentators who believe Mr Wheeler will be tougher – more "hawkish" – on inflation than his predecessor, Alan Bollard, the first line in today's monetary policy statement says "inflation is currently subdued, and is likely to remain low in the near term".

Price inflation, currently at an annual rate of 0.9%, is now not expected to reach the middle of the Reserve Bank's 1% to 3% target band until September 2015.

In the past, such a low rate in New Zealand would have pointed to minimal economic growth. However, today's forecasts show a slightly higher growth path through to March 2016.

Growth forecasts are up – a 3.3% rise in GDP is forecast for the year to March 2014 and a 2.9% increase the following year.

Driving this is a pickup in construction  in Auckland and Canterbury, growing business and consumer confidence generally and signs the offshore financial market instabilities of recent years have receded (even if they are unlikley to disappear completely for a very long time).

Trading partner growth is looking better than it was in 2012 – although global trading conditions are still below trend – and economic conditions among New Zealand's main export markets should be back to average long-term levels by the end of the year.

One new factor

Offsetting this is one new factor since the last update: the emerging drought in most of the country's farm regions and its likely impact on growth over the next two years.

Dairy output will take the main impact this year. One of the paradoxes of droughts is meat production usually rises as feed-denuded farmers reduce their stock numbers.

That, though, usually flows through into a drop in meat production the succeeding one or two years as farmers rebuild their numbers and send fewer animals to the freezing works.

The other restraints on the economy are the exchange rate and the government's "fiscal consolidation".

"The high New Zealand dollar continues to dampen export receipts and has resulted in increased competitive pressures in the tradable sector more generally," according to today's monetary policy statement.

The high currency has, at the same time, lowered the price of imports and thus price inflation and the costs of some business inputs, and has "also meant that interest rates are lower than would otherwise have been the case".

The government's tight fiscal stance is also having an impact. As well as restraining spending, the rise in indirect taxes – petrol and tobacco excises, as well as road user charges – along with tighter constraints on welfare payments  and student support packages, are having a contractionary impact.

"The government is also aiming to limit spending growth over the next few years, supported by a focus on improved state sector efficiency."

Overall, Mr Wheeler says, the recovery, while looking stronger than it did at his last full update in early December, is uneven.

"There are both upside and downside risks to this outlook. At this point we expect to keep the OCR unchanged through the end of the year."