Disbelief greets 'no cuts' pledge

Alan Bollard says the official cash rate will stay on hold but economists feel he will start cutting it this year.

The Reserve Bank expects to leave the official cash rate on hold at 7.25 per cent for the rest of the year, despite cutting growth and inflation forecasts and explicitly projecting lower interest rates in the medium term.

But market economists have not taken Governor Alan Bollard at his word.

In a Reuters poll yesterday, most still expect him to have cut the OCR at least once by the end of September and maybe three times by the year's end.

The futures market is less sanguine; it now has the first rate cut in October, a 50-50 chance of another in December and a total of 75 basis points by next March.

Economists interpreted the "no easing this year" comment as an attempt - so far successful - to stop wholesale interest rates from dropping further, especially in the key one- and two-year part of the yield curve from which the bulk of mortgage debt is priced.

"It's all about risk mitigation," said ANZ National Bank's acting chief economist, Cameron Bagrie. "It has stopped the market from going against him.

"He has ensured the one- and two-year lending rates stay up at current levels for another three months.

"He did not want to see swap rates fall and fixed mortgage rates testing 7.5 per cent, which could reignite the housing market."

Compared with the previous monetary policy statement in December, the Reserve Bank has shaved half a percentage point off its growth forecast for the March year just ending and the year ahead, to 2.5 and 1.5 per cent respectively.

And it now expects inflation to be back in the target band by the second half of this year.

"They have put out the fire but they are reluctant to turn off the hose," said Westpac chief economist Brendan O'Donovan.

Given those forecasts and the dovish tone of the statement, if the Reserve Bank had not said it would keep the OCR on hold for the rest of the year market interest rates would have dropped like a stone, O'Donovan said, and the dollar as well.

But Bollard left himself some wriggle room, qualifying the "no cuts this year" comment by adding that "any earlier easing would require a more rapid reduction in domestic inflation pressures than the substantial slowing already assumed in our projections".

Deutsche Bank chief economist Darren Gibbs believes the data will indeed come in weaker than the Reserve Bank forecasts. He expects the December quarter GDP growth figure to be only half the anaemic 0.4 per cent the bank forecasts.

Gibbs expects Bollard to start cutting the OCR in September and keep going until it is at a broadly neutral 5.75 per cent by April next year.

First NZ Capital economist Jason Wong said: "We continue to treat any forward-looking statements from the bank with a great deal of scepticism. It almost always shows a more conservative policy track than ultimately occurs - changes in policy almost always occur earlier and more vigorously than the bank projects."

Only three of the 15 forecasters Reuters polled expect the OCR to still be at 7.25 per cent by the end of the year: the Bank of New Zealand, ASB Bank and Infometrics.

BNZ research head Stephen Toplis said there was a real risk inflation could turn out higher than the Reserve Bank estimated, if the dollar fell faster than it expected (pushing up the price of imported goods) and if profit-squeezed firms were able pass on more of their costs. But Toplis thinks that in the two key inflation concerns the bank highlighted - wages and housing - it has little to worry about.