Inflation worries hold OCR steady

Reserve Bank Governor Alan Bollard left the official cash rate on hold at 7.25 per cent yesterday and effectively endorsed expectations that it will be at least a year before he cuts it.

In June, Bollard said there was no scope for an easing of the OCR this year, but yesterday he said: "A sustained period of adjustment in domestic spending is necessary and it will be some time before an easing in the OCR can be considered."

Most analysts took the change in language to suggest the bank was looking to maintain the OCR at present levels.

Westpac chief economist Brendan O'Donovan said the money market was already assuming the rate would not be cut before the second half of next year and saw Bollard's statement as confirming this.

Bollard said annual inflation was likely to stay near its present level of 4 per cent and it would be late next year before it was back within the bank's 1 to 3 per cent target range.

The bank remained wary of the risk that posed to the inflation expectations of those setting wages and prices.

But Bollard dampened market expectations that another interest rate rise might be on the cards, repeating that "we do not expect to have to tighten the OCR further this cycle".

That triggered a fall in short-term wholesale interest rates and the dollar dropped more than half a cent against the US dollar to close at US61.95c.

Even with the OCR on hold, the average mortgage rate borrowers are paying continues to rise because world interest rates are climbing, which pushes up the cost of the wholesale money banks use to finance fixed-rate mortgages.

Two-year rates have jumped to around 8.3 per cent, from 7.9 per cent two months ago.

"If it hadn't been for that, they would have put the prospect of a rate hike back on the agenda," said ANZ National Bank chief economist Cameron Bagrie.

The average rate being paid by borrowers whose mortgages have less than a year to run before being reset is about 7.5 per cent. A jump from that to 8.3 per cent would bite.

"There's a truckload of fixed rate mortgages rolling off over the next six months, especially in October, November and December," Bagrie said.

"So there's a fair bit of monetary policy tightening still in the pipeline."

The Reserve Bank needed the housing market to slow before it could be comfortable inflation would subside.

"It's not just a petrol story," Bagrie said.

The Bank of New Zealand's head of research, Stephen Toplis, said rising oil prices were putting upward pressure on short-term inflation but they were also pressing down on medium-term growth and, therefore, medium-term inflation.

Bollard said indicators of consumer demand and business activity had not slowed as much as expected.

Toplis said that suggested bottlenecks in the economy would take longer to be relieved, with the risk of higher-than-forecast inflation.

The BNZ was expecting a year of inflation above 4 per cent.

Bagrie said the Reserve Bank's talk of a "sustained period of adjustment in domestic spending" being necessary was its way of telling people to expect slow and sluggish growth for the next couple of years.

This was a hangover from the binge of the past few years.

Money market pricing implies the OCR will be cut in July next year but most economists are still picking March or April, though they admit the chances of it being later than that are increasing.