Bollard lifts OCR, future hikes likely to be less

The Reserve Bank has lifted the official cash rate from 2.75 to 3 per cent this morning.

The move, though widely expected, is a sign that the economy is still growing enough for bank Governor Alan Bollard to keep winding back the stimulus of record low interest rates, introduced at the height of the global economic crisis.

The OCR was last raised by a similar amount on June 10, the first time it had been increased by the Reserve Bank since 2007.

But today's statement paints a gloomier picture of the global economy than was evident in the June 10 Monetary Policy Statement, when Bollard cited a recovery in trading partner activity, led by Asia, Australia and the US.

The scale and speed of future increases in the OCR is now likely to be less aggressive.

Today's rate hike was predicted by all 20 economists in a Reuters survey and they expect Bollard will continue to lift the OCR back to more normal levels of 4 per cent to 5 per cent, ending the extraordinary stimulus in place since April last year when he cut the OCR to a record low 2.5 per cent.

Robin Clements, senior economist at UBS New Zealand said the Reserve Bank still viewed the OCR as "extremely stimulatory" and, as a base case, expects to continue reducing the extent of policy stimulus in the period ahead.

"However, the 'fragile', 'cautious' nature of the global and domestic recovery means that this process may not be in a straight line i.e. in reference to the 'pace' above, the Bank may not hike at every opportunity, with some pauses likely breaking the cycle. "

Darren Gibbs, economist at Deutsche Bank said he continued to think that a further 25bp hike in the OCR was "more likely than not" at the next meeting on September 16 - but is not guaranteed- followed by a "two meeting pause in the rate hike cycle in final quarter of this year".

ASB Bank economist Nick Tuffley said one new bit of information was that "the pace and extent of further OCR increases is likely to be more moderate than was projected in the June Statement."

"Our judgment is that the 3.5 per cent mark would be the more probable point for a pause, which would imply at the release of the December Monetary Policy Statement."

At 3.5 per cent the OCR would still be delivering effective interest rates that are still unequivocally stimulatory."

December would give the Reserve Bank another few months to assess the strength of the local economic recovery and "the risks hanging around the otherwise sunny global economic outlook, as well as some time to assess the impacts of the GST increase," said Tuffley.

He said he thought the OCR would not get as high as the 5.75 per cent market implied by the Reserve Bank in June. Tuffley said his view was that the OCR peak would be 5 per cent.

"We expect the Reserve Bank will continue to lift the OCR, and that it will move again by 25bp in September."

"While the outlook for economic growth has softened somewhat, it is still appropriate to continue to reduce the extraordinary level of support implemented during the 2008/09 recession," said Reserve Bank Governor Alan Bollard in a statement published this morning.

"The world economy continues its fragile recovery. Trading partner growth has turned out stronger than we predicted, however, future prospects for growth have deteriorated. While still at high levels, our commodity prices have moderated," he said.

"In New Zealand, domestic demand is subdued. Households are cautious, with retail spending growing only modestly, housing turnover in decline and household credit growth weak. While this caution has been evident for some time, the recent slowing in net immigration will act to further dampen consumer spending. Business investment remains very low, with corporate lending continuing to be subdued.

Bollard said the New Zealand dollar had appreciated in recent weeks, something that was "inconsistent with the softening in New Zealand's economic outlook and moderation in our export commodity prices."

"Overall, we continue to predict respectable near-term GDP growth, with manufacturing confidence remaining elevated and forestry exports continuing to expand. An eventual recovery in business investment will assist growth over the medium term.

Annual CPI inflation had been near 2 per cent for the past five quarters. As the economy grows, inflationary pressures were expected to pick up.

"Given this, some further removal of monetary policy stimulus is appropriate at this stage. Even after today's move, the level of the OCR is still very supportive of economic activity. The pace and extent of further OCR increases is likely to be more moderate than was projected in the June Statement. Our policy assessment will be continually reviewed in light of economic and financial market developments," he said.

Bollard said the coming increase in the rate of GST and other government-related price changes were likely to temporarily push annual CPI inflation above 3 per cent.

"The Bank does not expect this price spike to have a lasting impact on inflation. However, the price and wage setting behaviour of firms and households will be monitored for evidence of any increase in inflation expectations."

Trade unions and Federated Farmers have urged the Reserve Bank to keep interest rates low, saying that the economic recovery is not yet strong enough to remove the stimulus of low rates.

A leading business confidence indicator released yesterday showed a third consecutive monthly fall, with confidence almost halving since reaching a decade high in February.

-NZ HERALD/ BUSINESSDESK

See a history of Reserve Bank OCR rates here.

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