OCR left at record low 2.5pc

Reserve Bank Governor Alan Bollard. Photo / Mark Mitchell.

Reserve Bank Governor Alan Bollard held the official cash rate at 2.5 per cent and said a strong New Zealand dollar will ensure interest rates stay lower for longer by keeping imported inflation in check while eroding the value of exports.

"While helping contain inflation, the high value of the New Zealand dollar is detrimental to the tradeable sector, undermines GDP (gross domestic product) growth and inhibits rebalancing in the New Zealand economy," Bollard said in a statement. "Sustained strength in the New Zealand dollar would reduce the need for future increases in the OCR."

Bollard has kept the benchmark interest rate on hold since March last year, when he sliced half a percentage point from the OCR as an insurance measure to shore up business confidence in the immediate wake of the Christchurch earthquake. He signalled a tighter policy in the latter half of the year, but pushed that out as Europe's sovereign debt woes escalated, threatening to drive up funding costs for local lenders.

Those foreign concerns have eased as European policymakers took steps to protect the region's financial stability, helping drive up the kiwi dollar, which has climbed almost 7 per cent on a trade-weighted basis since the December monetary policy statement.

The bank lifted its forecast for the kiwi dollar, with the TWI expected to hold above 70 until the December quarter next year. The Reserve Bank had previously expected the TWI to fall to 65 from 67 over that period.

The New Zealand dollar fell to 81.64 US cents after the statement from 81.91 cents immediately before. The TWI was at 72.54 from 72.77.

Bollard sliced the top end for the track of the 90-day bank bill, often seen as a proxy for the OCR, with it settling at 3.6 per cent at the tail-end of 2014. The bank had previously projected it would rise to 4 per cent by September next year. It has removed any sharp increases in the bank bill rate that were previously flagged for the second half of this year.

Tepid inflation has let Bollard stay his hand, with an unexpected contraction in consumer prices in the last three months 2011. With little inflation pressure coming from wage negotiation and producer prices, the central bank can afford to wait until the reconstruction effort in Canterbury begins in earnest.

Bollard said the bank's inflation expectations have fallen, and the current rate is settled near the middle of its target 1 per cent to 3 per cent bank.

The bank slashed its forecast for annual inflation through this year by as much as 90 basis points in the September quarter when the consumer price index is expected to touch 1.4 per cent.

Earlier this week, the New Zealand Institute of Economic Research's 'shadow board' recommended Bollard keep interest rates at or below the current level. That comes after Westpac Banking saw the flicker of rising interest rates on the horizon, and encouraged homeowners to switch their mortgages into fixed terms.

That's also seen traders start betting on an earlier rate hike than expected, pricing in 24 basis points of increases over the coming 12 months, according to the Overnight Index Swap curve.

The central bank was more optimistic in its forecast for GDP growth in the 2013 March year, lifting its expected expansion 60 basis points to 3.7 per cent, while keeping projections for the other years largely unchanged.

That comes after the Treasury cut its pre-election forecasts in last month's Budget Policy Statement, citing the impact of slower global growth. The department shaved almost half a percentage point from expected GDP growth in the 12 months ended March 31, this year, though that is expected to be made up in 2014.

The easing of global financial stress meant the central bank's fears of rapid growth in local lenders' funding costs didn't emerge, and the Reserve Bank only expects modest increases this year.

See the full Monetary Policy Statement here.