Bollard leaves cash rate unchanged

Alan Bollard

Reserve Bank Governor Alan Bollard today left interest rates unchanged in his six-weekly review - as all economists expected - and reiterated his comments last month that he sees no scope for cutting rates this year.

The Official Cash Rate remains at 7.25 per cent as it has been since December.

Dr Bollard painted a worst-of-all-worlds economic picture. Since the bank's full review of the economy in March, activity had weakened faster than expected and short-term inflation pressures had intensified, fuelled by soaring petrol prices and the effects of a falling exchange rate.

Inflation, running at 3.4 per cent annually, has been outside the bank's 1-3 per cent target band for three quarters and is now expected to pick up further and stay higher for longer.

"Despite the easing in resource pressures, the short-term inflation outlook has worsened," Dr Bollard said in his statement today.

"The exchange rate drop will boost import prices," he said. "We also expect significant further price rises over coming quarters as a result of the ongoing world oil shock."

He said that would keep inflation above 3 per cent for longer than previously projected and risk putting upward pressure on inflation expectations.

In March, the bank forecast infaltion would come down from a projected 3.2 per cent in the June 2006 year to 2.75 per cent by the second half of the year. It was projected to hold around 2.5 per cent in 2007. However, private sector economists now expect inflation to be between 3.6 and 3.8 per cent in the June year.

Dr Bollard said he would not try to counteract the "one-off" boost to prices from the exchange rate and oil price shocks. "In this regard we still do not expect to raise interest rates again in this cycle."

However, he warned he would remain "vigilant against these shocks spilling over into inflation expectations, and wage and price-setting behaviour".

Dr Bollard said the anticipated slowdown in domestic demand was expected to continue through this year. Economists say the economy has been at a virtual standstill for three quarters.

Dr Bollard said that the domestic slowdown would be partly offset by growth in exports and import substitution as a result of the decline in the New Zealand dollar.

Recent economic indicators suggested the economy would continue to grow modestly through 2006, he said.

The National Bank's survey of business confidence out yesterday showed confidence improved but was still deeply negative. However, businesses' own expectations picked up. There has also been a revival in immigration and the housing market, the root of many of Dr Bollard's inflation concerns, has remained relatively buoyant.

Dr Bollard, as usual, refused to answer questions on the reasons for his decision.

The New Zealand dollar, which firmed overnight to US63.32c, eased a few pips to US63.23c after the statement.

Economists were divided on whether they believed Dr Bollard would not ease rates this year.

First NZ Capital economist Jason Wong was sceptical.

"We're still looking for an easing later this year."

But Goldman Sachs JBWere economist Shamubeel Eaqub said the slowdown was too mild and inflation pressures too high to entertain interest rate cuts this year.

"Certainly it puts a risk to our view that there will be a September cut and we will be looking into it.

"I think the main impact will be on the currency as the expectations get pushed back, the New Zealand dollar will find support above current levels for the next three to six months."

- NZPA