NZ dollar gains as OCR held

Reserve Bank Governor Alan Bollard File photo

Reserve Bank Governor Alan Bollard flagged a brighter future for this year as he kept the official cash rate at 3 per cent, as expected, and says he needs to see a "more robust" recovery before his starts tightening again.

The New Zealand dollar climbed more than half a U.S. cent to
77.12 US cents immediately after Bollard said forward-looking indicators had firmed and trading partner activity picked up amid rising prices for locally produced raw materials.

Still, he said rates will stay at a stimulatory level "until the recovery becomes more robust and underlying inflationary pressures show more obvious signs of increasing."

The economic recovery struggled to take hold in 2010, and narrowly dodged slipping back into recession, with an unexpected contraction in the third quarter and minimal growth in the second.

The New Zealand dollar's gain "is looking like that's coming on the forward-looking indicators - it won't be sustained as the statement's very similar to December's," said Philip Borkin, economist at Goldman Sachs & Partners.

The central bank expects quarterly economic growth to peak at 1.4 per cent in the September quarter this year, as local commodity prices stay at record highs amid surging global demand for agricultural raw materials.

The New Zealand Institute of Economic Research's December quarterly survey of business opinion showed a slow turnaround in firms'
outlook for the coming year. Add to that the stimulus from rebuilding Canterbury in the wake of last September's 7.1 magnitude earthquake and the Rugby World Cup later this year and the prospects for the economy are more upbeat.

Still, Borkin said he's not expecting the same kind of robustness until the second half of next year, and doesn't forecast a rate hike until September.

Last month, Bollard reined in his expected track of rate hikes, citing the stalling recovery. He sliced more than a percentage point from its already-pared back forecast track for the 90-day bank bill, and expects the rate will stay below 4 per cent until the June quarter next year. Traders are betting Bollard will add 66 basis points to the OCR over the coming month, according to the Overnight Index Swap curve.

Bollard will tomorrow offer his big-picture view of New Zealand's economy when he gives his opening speech for the year at the Canterbury Chamber of Commerce.

The speech is entitled 'Looking into the crystal ball: A forecast and some risks ahead.'

Benign underlying inflation will help Bollard keep rates lower for longer, with the fourth-quarter consumer price index meeting expectations at a pace of 2.3 per cent, of which 2 percentage points could be attributed to the government's hike in the goods and services tax.

Bollard said the increase in GST bolstered headline CPI inflation, "but underlying inflation remains comfortably inside the target band" of between 1 per cent and 3 per cent.

The low interest rate environment has had the perverse effect of holding back the recovery as households take advantage of the climate to repay outstanding debt in favour of ramping up spending.

That's kept retailers on the back foot, with November data showing core consumer spending unexpectedly fell in that Christmas period. Retailers have been forced to discount prices, and half of those surveyed by Statistics New Zealand hadn't passed on the hike in GST.

The nation's indebtedness has also raised the ire of the government, which is desperately trying to avoid a credit rating downgrade with a negative outlook hanging over its head.

To combat this, Prime Minister John Key yesterday said his administration will cut new spending by as much as $300 million a year, and look at selling down its holdings in electricity retailers Genesis Energy, Meridian Energy, Mighty River Power, coal miner Solid Energy, and carrier Air New Zealand.

Bollard took a swipe at government spending in the December monetary policy statement, with a break-out box saying the Crown accounts were about 7 percentage points worse than in 2008, with much of the deterioration in the fiscal position appearing structural, "which will persist even as the effects of the recession fade."

The property market spent most of last year in the doldrums as sales volumes slumped and values receded. The bank forecasts property values to modestly extend their decline this year.

ASB chief economist Nick Tuffley said the housing market is still "very fragile and unlikely able to withstand interest rate increases for some time, particularly as house prices continue to decline."

He expects Bollard will stay on hold until December, with the pace of hikes accelerating to a peak of 4.5 per cent.