OCR left unchanged at 3.5pc

The Reserve Bank of New Zealand kept the official cash rate at 3.5 per cent and said it may have to lower the rate should demand and inflationary pressures track lower than would be consistent with its inflation target.

Governor Graeme Wheeler changed his language compared to the March 12 monetary policy statement, dropping any reference to the possibility of rate hikes, repeating that the kiwi dollar is unjustifiably and unsustainably high and painting a weaker picture of trading partner growth.

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"The timing of future adjustments to the OCR will depend on how inflationary pressures evolve in both the non-traded and traded sectors," Wheeler said. "It would be appropriate to lower the OCR if demand weakens, and wage and price-setting outcomes settle at levels lower than is consistent with the inflation target."

A change of tone was anticipated after assistant governor John McDermott said last week that the bank isn't currently considering any increase in rates. Wheeler repeated those words today, saying the bank expects to keep monetary policy "stimulatory".

The New Zealand dollar dropped half a cent on the news to 78.43 US cents from 79.02 cents just prior to the release.

Inflation is now close to zero, rising at an annual rate of just 0.1 per cent in the first quarter, the smallest annual movement since the year to September 1999. The central bank's MPS forecasts of last month have annual inflation staying below the mid-point of its 1 per cent-to-3 per cent target band through until at least March 2017.

McDermott said last week that much of the weakness reflected falling fuel prices and, assuming crude oil doesn't extend its 50 per cent slump since July 2014, would drop out of the inflation rate at the start of 2016. Today Wheeler said underlying inflation remains low "and is expected to pick up gradually."

"Monetary policy will focus on the medium-term trend in inflation," Wheeler said.

The New Zealand economy continues to grow at an annual rate of about 3 per cent, helped by low interest rates, high net immigration, construction activity and the decline in fuel prices, he said. House price inflation "is elevated in Auckland."

Weighing on growth, though, were lower dairy incomes, the lingering effects of drought, fiscal consolidation and the high kiwi, which on a TWI basis is above the average 76.7 level the bank had projected for the second quarter.

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"We are watching closely the ongoing impact on tradables inflation from global forces and the high dollar," Wheeler said. "On a trade-weighted basis, the New Zealand dollar continues to be unjustifiably high and unsustainable in terms of New Zealand's long-term economic fundamentals. The appreciation in the exchange rate, while our key export prices have been falling, is unwelcome."

Traders may pick up on the use of the word 'unwelcome' as they try to gauge the bank's willingness to intervene in currency markets, a tactic it rarely uses, but for which it has some billions of dollars available.

Wheeler's take on trading partner growth is less upbeat than was the case in last month's statement, when he said growth this year was expected to be at a similar pace to 2014. While he said today that trading partner growth "continues at around its long-term average", it "remains dependent on highly accommodative monetary settings."

"Looking ahead, considerable uncertainties exist in Europe, China and Australia, and on the timing of US monetary policy adjustment, although global growth should be boosted by the decline in world oil prices," he said.