OCR hiked to 3.25pc, dollar jumps

Reserve Bank Governor Graeme Wheeler announced a rise in the Official Cash Rate of a quarter of a percent during a press conference in Wellington today. File photo / Mark Mitchell

The Reserve Bank of New Zealand raised the official cash rate for a third time while keeping its track for interest rates broadly in line with its March projections, suggesting the bank sees no need to pause in removing stimulus in an accelerating economy. The New Zealand dollar jumped three quarters of a cent against the US dollar following the announcement.

Governor Graeme Wheeler raised the OCR to 3.25 per cent, as expected, saying as inflationary pressures are expected to increase, "it is important that inflation expectations remain contained and that interest rates return to a more neutral level."

Gross domestic product grew an estimated 4 per cent in the year to June, and has "considerable momentum," he said. While low interest rates had played an important part in supporting growth in the past few years, "more recently, growth has become more self-sustaining and very low interest rates are no longer appropriate given the rise in inflationary pressures."

The New Zealand dollar touched a three-week high of 86.27 US cents following the announcement, and was recently trading at 86.22 cents, from 85.50 cents immediately before the 9am announcement.

Wheeler is signalling no pause in the tightening cycle to a market that has moderated its expectations for hikes in the OCR this year by about 15 basis points since March. Based on the Overnight Interest Swap market at the end of May, the market had priced in the OCR reaching 3.7 per cent by March 2015 compared to the 3.85 per cent being priced in at the time of the March MPS.

See today's full Reserve Bank Monetary Policy Statement here:

The Reserve Bank attributed this change to overseas investors being the dominant market participants driving rates lower, "more than offsetting the flows from domestic banks wanting to fund fixed rate mortgages that put upward pressure on rates."

The impact since March has been less than the bank wants because lenders have benefited from lower global wholesale rates and have less need to seek funding because of the inflow of deposits. Added to that, rivalry in the home loan market means lenders have been keep mortgage rates lower than expected.

The Reserve Bank signalled in March it may hike the OCR by 200 basis points over two years and the monetary policy statement does nothing to moderate that view. The 90-day bank bill rate, seen as a proxy for the OCR, is projected to be 4 per cent by year-end, unchanged from the March MPS. Since then the bank bills have gained to 3.46 per cent from around 3.07 per cent.

By the end of 2015, the central bank sees the 90-day bank bills at 4.7 per cent, little changed from the 4.9 per cent rate it saw in March.

Annual inflation breaks through the mid-point of the bank's 1 per cent-to-3 per cent target range in the June quarter of 2015, at 2.1 per cent, three months earlier than was projected in the March MPS, before slipping back to 1.9 per cent.

Part of that is driven by the central bank's assumption that current price pressures moderate. It notes that "strong increases in construction spending will support robust domestic demand over coming years" and expects the sector will grow to about 10.5 per cent of potential GDP in the next two years.

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Strong net immigration and income growth will boost housing demand, but house price inflation is expected to moderate as more supply becomes available, the bank said.

New Zealand property values increased at an 8.2 per cent annual pace in May, the slowest in nine months, according to QV data, suggesting the Reserve Bank's loan to value restrictions have cool demand.

The bank's projections assume that annual net immigration peaks in mid-2014 at 37,000 working-age people, with some 70,000 people added to the population over its forecast horizon to June 2017.

Yet the composition of migration means it is likely to stoke demand less than in the peaks of the early 2000s, mainly because much of the increase reflects a drop in New Zealanders moving overseas and more kiwis returning home, "encouraged by New Zealand's relatively favourable economic performance."

"We think that market expectations for a significant downgrade in the RBNZ's interest rate forecasts will be disappointed," Imre Speizer, director, NZ rates strategy, at Westpac Banking Corp, said before the MPS was released. "The data flow since the last MPS has been mixed. Soft inflation and wage costs, lower dairy prices and a high NZD have been offset by stronger migration, lower mortgage rates, and a fiscal impulse."

The biggest revisions to the bank's provisions are for the track of the trade-weighted index, which was recently at 79.83 from 79.97 at the time of the last MPS on March 13. The central bank expects the TWI to average 80 in the June quarter, up from its March projection of 78.4, and hold above 79 through 2014, before declining in 2015.

"Our projection assumes that the TWI falls gradually, by about 7 per cent over the next three years," Wheeler says in the monetary policy statement released today. "To date, the fall in the currency has been smaller than the drop in commodity prices would suggest. If the exchange rate remains strong, it is likely to be reflected on continued low or negative tradables inflation."