Domestic weakness surprises Bollard

Alan Bollard has defended his decision to raise the OCR by a cumulative 50 basis points in June and July. Photo / Mark Mitchell

A downbeat monetary policy statement from the Reserve Bank yesterday bolstered expectations that it will be June next year before Governor Alan Bollard raises the official cash rate again.

The Reserve Bank yesterday held the official cash rate (OCR) at 3 per cent.

The bank has been surprised at how weak the domestic economy has proven, drawing the conclusion that low interest rates are having a less stimulatory effect than in the past.

It is foreshadowing at least one less OCR hike over the next two years than it did in its September statement - and that was already a significantly more cautious view of the outlook for growth and interest rates than the bank had earlier in the year.

But appearing before Parliament's finance and expenditure committee Bollard rejected accusations from Labour's Shane Jones that he had got it wrong when he raised the OCR a cumulative 50 basis points in June and July and that the country was paying a price for that in a higher dollar.

"If we were to get a softer year out through next year then you might be able to argue it was premature. But that is not the picture we have got at the minute," he said. "The New Zealand dollar is where it is for a range of reasons. One of them is strong commodity prices. Another is quantitative easing in the United States and some very big currency flows internationally that don't really have much to do with New Zealand at all."

The dollar dropped about half a cent to US74.5c immediately after the announcement and by a similar amount against the Australian dollar. Short-term wholesale interest rates fell. The bank now expects the annual average growth rate to stay below 2 per cent for most of next year - about 1 per cent less than it forecast previously - but that will accelerate to almost 4 per cent by the middle of 2012, which is about 1 per cent more than previously expected.

The rebuilding and repairing activity necessitated by September's earthquake in Canterbury is forecast to contribute 1 per cent to activity next year and a similar amount the year after.

But the bank sees the risk around these forecasts as asymmetric - things are more likely to turn out worse than better.

Drought is one risk.

Another is a deterioration in the international outlook, either from a sharp slowdown in a major trading partner or a marked increase in banks' offshore funding costs.

And there is the risk of further declines in house prices, depressing household spending.

The bank's central forecast includes some softening - about 1 per cent over the next six months - in house prices before improvements in the labour market induce some recovery. But the downside risks cannot be ignored, it says.

The statement's projected track for the OCR has it reaching 4.5 per cent by early 2013.

Even then it would be lower than it was at any point during the nine years from the start of 2000 to the end of 2008. Offsetting that is a persistently much wider margin than before the global financial crisis between the OCR and the cost of funds banks face. ANZ chief economist Cameron Bagrie broadly agreed with the tone of the statement. "We believe the economy is in a soft patch that will persist for the next six months," he said.

"However we do see a risk that the Reserve Bank is too bearish on prospects for the second half of 2011 and hence may be too low in its assessment of where the OCR will ultimately end up. But evidence of this still remains a way off."

ASB economist Jane Turner said that historically the Reserve Bank had pre-empted future inflation pressures. But in the much more uncertain world since the crisis it wanted to be more confident that the recovery is firmly under way and that inflation pressures are actually increasing.

"It wants to see which reality we are in coming out the other side of the crisis. That is hard to do right now without a Tardis or some other time travel gadget," she said.

Looking ahead

* 3pc The official cash rate, held steady yesterday by the Reserve Bank.

* 4.5pc Where the bank expects the official cash rate to be by early 2013.