The door remains open to further official cash rate cuts after the Reserve Bank held the OCR steady while predicting inflation will pick up as the impact of low oil prices eases.
Governor Graeme Wheeler said monetary policy would remain "accommodative" following yesterday's announcement that the rate would stay at 2.25 per cent.
The market had put a roughly 50 per cent chance on the rate being unchanged.
"We expect inflation to strengthen as the effects of low oil prices drop out and as capacity pressures gradually build," Wheeler said. "Further policy easing may be required to ensure that future average inflation settles near the middle of the target range [1 to 3 per cent]."
The New Zealand dollar rose on the back of yesterday's statement, trading at US69.33c at 5pm up from US68.34c before the announcement.
The Reserve Bank, which cut the OCR by 25 basis points to a record low of 2.25 per cent last month, faces a conundrum as it struggles to manage conflicting economic pressures. It needs to keep rates low to spur inflation - currently tracking at a 0.4 per cent annual rate - back to within the target range, while also being mindful of the impact low interest rates are having on New Zealand's heated housing market.
A resurgent New Zealand dollar and slump in oil prices, meanwhile, are keeping prices down.
Deutsche Bank economist Darren Gibbs said the language in yesterday's announcement was identical to that used last month, showing the Reserve Bank's "easing bias" remained intact.
"We think that it is reasonable to assume that the RBNZ's cental scenario remains that one further 25 [basis point] cut in the OCR will be delivered in this cycle, but this is not guaranteed," Gibbs said.
"Looking ahead, as far as the 9 June meeting is concerned we presently think that an easing is more likely than not, especially given the likelihood that the exchange rate will remain more resilient than the bank desires ... "
ASB economists said the announcement gave no hint that the Reserve Bank was anticipating a need to cut the OCR below 2 per cent.
"Nonetheless, we still see downside risks to the inflation outlook and expect the RBNZ will cut the OCR to 1.75 per cent by August," they said. "Further OCR cuts will give the housing market even more of a boost and bring the RBNZ's financial stability mandate into more conflict with the price stability goal. It is increasingly likely that, if the RBNZ cuts the OCR further, it also expands its current lending restrictions." Wheeler said the exchange rate remained "higher than appropriate" and there were indications that house price inflation in Auckland was picking up.
Last month Wheeler cut the benchmark rate to a record low to try to prevent weak inflation from embedding into wage and price setting behaviour. That surprised economists after Wheeler had earlier said he was able to look through price shocks, calling the focus on the consumers price index a "mechanistic approach".
The Reserve Bank doesn't see inflation moving back within the target 1 to 3 per cent range until December this year. Still, an increasing number of firms surveyed by the New Zealand Institute of Economic Research said they intended to raise prices this year, something they've struggled to do in the past.
Wheeler said imports and cheap fuel were keeping headline inflation low, but that annual core inflation was within the bank's target, and that long-term inflation expectations were "well-anchored" at 2 per cent.
The local economy was still being supported by strong inward migration, construction, tourism and low interest rates, and while dairy prices had increased they were still below breakeven levels for farmers, Wheeler said.
Further complicating matters for Wheeler is the continuation of extraordinary monetary policy among the major central banks, with European and Japanese authorities persisting with money-printing programmes, and the US still reluctant to raise rates. The Federal Reserve yesterday kept the federal funds rate at between 0.25 per cent and 0.5 per cent, and reaffirmed its path to higher rates was a gradual one.
• Reserve Bank keeps OCR at record low 2.25%.
• New Zealand dollar rose on the back of decision.
• Inflation tracking at a 0.4% annual rate.
• Low interest rate needed to spur inflation.
• Bank will be mindful of impact on housing market.
- Additional reporting BusinessDesk