No rate change from Bollard

Dr Bollard

As widely expected, the Reserve Bank today left official interest rates unchanged at 7.25 per cent.

Reserve Bank Governor Alan Bollard warned it would be "some time" before an easing could be considered.

The Official Cash Rate (OCR) has now been at its current level since December as the Reserve Bank seeks to return inflation to its 1-3 per cent target range from the 4 per cent annual rate hit in the June quarter.

Today, Dr Bollard appeared to offer some comfort from fears the OCR could go even higher, but home buyers received no relief with suggestions rising mortgage rates had some way to go.

"While second-round wage and price effects remain a risk, we do not expect to have to tighten the OCR further in this cycle," he said.

"However, 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.

"Certainly we will need to be confident that future inflation is heading back comfortably within the target range," Dr Bollard said.

While recent economic developments were broadly in line with the Reserve Bank's June Monetary Policy Statement, economic activity was a little stronger than expected, with indicators of neither consumer demand nor business activity softening to the degree anticipated.

Slightly more short-term inflation pressure was also being seen as a result of rising oil prices.

Headline annual Consumer Price Index inflation was likely to persist around the 4 per cent annual level hit in the June quarter for several quarters to come, he said.

"Our medium-term view is for underlying inflation pressures to trend downwards."

Economic growth was forecast to stay subdued through 2006 and 2007, with CPI inflation expected to return to the 1-3 per cent target range by late-2007, Dr Bollard said.

"The rebalancing of economic activity -- away from domestic demand and towards exports and import substitution -- is expected to continue and will help to alleviate domestic inflation pressures.

"The rebalancing will be supported by the weaker New Zealand dollar exchange rate and ongoing upward pressure on effective mortgage rates.

"Foreign interest rate trends and domestic market expectations are both now working to support our domestic policy stance."

In his quarterly review of monetary conditions in early June, Dr Bollard said that given the unavoidable nature of exchange rate and oil price shocks, it would be inappropriate to counter the short-term effects.

As this country was an oil importer, higher prices must inevitably mean a reduction in individuals' real spending power, he said at the time.

The New Zealand dollar dipped about 20 basis points immediately after the announcement to US62.38c.

Citigroup Global Markets economic and market analysis director Annette Beacher said financial market reaction was a "relief rally" due to the Reserve Bank (RBNZ) ruling out further tightening.

Citigroup remained comfortable with its view of an unchanged cash rate for the next year.

"We expect the RBNZ to watch and worry over the 4 per cent inflation rate, and maintain a hawkish bias at each opportunity in order to contain inflationary expectations and wage-setting behaviour," she said.

Citigroup expected inflation to stay at 3.5 per cent or higher well into early next year.

It had scheduled swift consecutive OCR reductions from June 2007 to December 2007, for an end-2007 target of 6 per cent, or more "neutral", in order to facilitate the GDP returning to trend in 2007-08.

TD Securities chief strategist Stephen Koukoulas said the forecast that inflation was going back to within the target range in the second half of 2007 was a sign of the R BNZ acknowledging the softening in leading economic indicators.

The RBNZ was hinting quite clearly that a rate cut was almost certainly the next move, even though Dr Bollard ruled it out in the short-term.

ANZ National Bank head of market economics Cameron Bagrie said that without a smoking gun to suggest a rate hike was back on the agenda the market had naturally rallied and the currency had come under a bit of pressure.

The tenor of Dr Bollard's statement was basically unchanged from June, which was the right assessment given recent economic developments, he said.

"Interestingly the RBNZ is flagging a longer period of sustained economic weakness with subdued domestic spending which portends interest rates being kept high for a little bit longer than what they were saying in the June statement."

Deutsche Bank chief economist Darren Gibbs said the market had got itself into a bit of a "tizz" over the possibility of further hikes but RBNZ was playing it pretty cool.

- NZPA