Graeme Wheeler: Market got ahead of itself

Reserve Bank Governor Graeme Wheeler at a press conference in Wellington. New Zealand Herald Photograph by Mark Mitchell

Financial markets were wrong-footed and the Kiwi dollar plunged after the Reserve Bank indicated that it was in no great rush to raise official interest rates today.

The bank, as expected, kept its official cash rate at 1.75 per cent, but few were prepared for its "dovish" assessment of inflation and of where rates go from here.

In addition, the bank's forecast of the future official interest rate track was the same as that published in February, showing a late 2019 start to the tightening cycle and running contrary to market expectations that it would start tightening much earlier in that year.

Reserve Bank Governor Graeme Wheeler said the market had seen strong growth and had anticipated that there would be a significant build up in inflation pressure.

But the Reserve Bank had looked closely at data and seen little evidence of a build-up in wage inflation.

It had noted the slightly weaker economic performance in the last six months of 2016 which suggested capacity pressure may be less than had been anticipated.

It had also been the case that the spike in inflation during the first quarter of the year - taking annual inflation to 2.2 per cent - was driven by tradable goods such as oil and food prices, Wheeler said

"We don't expect to see continuing sharp increases in those commodities. So in terms of annual inflation calculations, they're going to wash out of the system," he said.

Wheeler acknowledged that there was inflation pressure building in the construction sector but essentially longer-term trends for underlying inflation had not warranted a change to the Reserve Bank's neutral stance, he said.

"So it's a situation where we'll watch things very carefully but at this point we felt the market had got a bit ahead of itself."

There had also been some rises in mortgage rates in the past few months so the banking system was essentially doing some of the tightening for the central bank, he said.

In the foreign exchange market, the New Zealand dollar - which in the past has been elevated by what have been relatively high interest rates - fell sharply on the likelihood that rates were likely to remain lower for longer.

By mid-afternoon, the kiwi was trading at US68.2c down US1c from its level just before the release at 9am.

Against the Aussie dollar the kiwi was at A92.98c, down by just more than A1c.

"The upshot was that it disappointed the market because they did not move the [interest rate] track at all and they were much less upbeat about the outlook than all the economists had expected," said Westpac senior markets strategist Imre Speizer.

ANZ senior economist Phil Borkin said: "They remain absolutely stuck in neutral."

"The main message from them is that we are not budging policy for a considerable period. They are looking through the recent developments and still focusing on a lot of uncertainties out there," Borkin said.

Wheeler did note that the housing market, and in particular in Auckland, had continued to cool this year.

"We are certainly pleased to see the moderation," he said. "If you look at Auckland prices over the last eight months they've actually fallen slightly."

Wheeler said the central bank genuinely did not know the extent to which the slowdown would be sustained.

Migration rates were still high and that while mortgage rates had risen they remained low by historic standards, he said. While building permits were at an 11-year high, supply was still not coming on quickly enough.