Bollard leaves cash rate unchanged amid gloomy forecasts

Alan Bollard

Reserve Bank governor Alan Bollard offered no winter cheer today when he left the Official Cash Rate (OCR) unchanged at 7.25 per cent, as was universally expected.

In a gloomy set of quarterly economic forecasts, the governor said both the inflation and growth outlook had deteriorated since the March forecasts.

Inflation was set to climb to nearly 4 per cent this quarter -- its highest level in five years.

It was forecast to ease in the September quarter but return to 3.9 per cent in the December quarter before easing back.

Inflation, which has been above the bank's 1-3 per cent target for three quarters, was projected to remain above 3 per cent well into next year.

Dr Bollard blamed rising oil prices and the sharper than projected fall of the New Zealand dollar for the deterioration.

While he said he was not planning to hike interest rates again, he reiterated comments that he saw no scope to lower the OCR this year.

Dr Bollard said that given the "unavoidable nature of these price shocks" it would be inappropriate to counter the short-term effects.

"We do not expect to tighten policy in response to the high headline inflation in the short-term.

"But equally, we cannot afford to ease policy until we have more certainty that future inflation outcomes will be trading down comfortably below 3 per cent.

"Given this situation, we see no scope for an easing of the OCR this year."

Dr Bollard said the economy had slowed faster than he had anticipated.

Economic growth was expected to remain low this year -- at 1.6 per cent in the year to March 2007 -- before recovering to a more respectable 2.7 per cent the following year.

The economic "rebalancing' that had begun, with lower domestic demand and stronger exports, would continue.

Exports though, would only recover slowly while the domestic economy battled the "headwinds" of higher petrol prices and interest rates.

Dr Bollard still believed the economy was in for a "soft landing".

In one of the few pieces of good news on offer, Dr Bollard believed oil prices have peaked.

The bank projected the international price of a barrel of crude oil would fall from around US$70 ($113) to US$45 by 2008.

Petrol prices were projected to fall to around $1.58 a litre by early next year from around $1.70 at present.

However, Dr Bollard said that because New Zealand was an oil importer, higher prices "must inevitably mean a reduction in individuals' real spending power".

He warned that if the "short-term spike" in inflation be passed through more aggressively into wage and price-setting behaviour, or inflation expectations, medium-term inflation pressures could be stronger and there would be monetary consequences.

Dr Bollard expected house inflation to slow -- as he has incorrectly predicted for several quarters -- and saw some softening in house prices despite positive net migration to New Zealand.

He admitted the strength of immigration had surprised the bank -- that it was historically unusual to have net immigration when New Zealand's economy was growing slower than its trading partners.

"We expect house prices to undergo a sustained period of adjustment. We are projecting a sharp decline in house price inflation over the coming years comparable to the recent housing market slowdown in Australia," he said.

However, he admitted to "considerable uncertainties" around this projection -- that house prices had surprised the bank in the past "and there is a chance they could surprise us again".

UBS economist Robin Clements said little had changed since the bank's pronouncements in March and April.

"Many in the market, including myself, think there will be rate cuts later this year. The Reserve Bank say there won't but I don't think this will change people's minds other than the fact we have moved on a period of time."

ANZ National Bank chief economist Cameron Bagrie said it was a largely a repeat of what the bank said in April.

"I think the message from that is that while they're ruling out cuts for 2006, they likewise don't expect to cut interest rates in the first quarter of 2007."

The New Zealand dollar firmed slightly to US62.86c from US62.66c just before the rate decision.

- NZPA