Interest rate unchanged at 5.75 per cent, Bank hints at cut

11.30am

The Reserve Bank has kept New Zealand's key interest rate unchanged but foreshadowed a cut later this year if the strong currency remains in form.

The decision to keep the Official Cash Rate (OCR) steady at 5.75 per cent for the sixth straight month was in line with most economists' expectations.

Bank governor Alan Bollard said today the higher exchange rate would dampen future activity and medium-term inflation pressures.

The New Zealand dollar rose 10 per cent against the United States dollar in December and 3.8 per cent against the Australian dollar.

It is currently hovering at a nearly four-year high against the US dollar, and was virtually unchanged after the announcement.

Dr Bollard said domestic activity was more robust than expected, as reflected in household spending indicators and construction sector activity.

"The latest estimates suggest that domestic inflationary pressure has continued, offsetting a fall in imported inflation."

The OCR, which influences the interest rates that banks charge customers, is one tool the Reserve Bank has to keep inflation within a range agreed with the Government.

Inflation as measured by the Consumers Price Index (CPI) is currently running at 2.7 per cent annually.

"As expected, overall CPI inflation has remained towards the upper end of the 1 per cent to 3 per cent target band for inflation over the medium term," Dr Bollard said.

"For the moment it is appropriate to leave the OCR unchanged, reflecting the strong growth in the New Zealand economy. However, the balance of risks around the future path of interest rates has shifted.

"If the exchange rate remains at present levels or appreciates further, and if the evidence points to reduced pressures on resources and medium-term inflation, then there may be scope for a cut in the OCR later in the year."

The Reserve Bank delivers its next decision on interest rates with the release of the Monetary Policy Statement on March 6.

Exporters and manufacturers have called for the bank to cut interest rates, with the latest survey by the New Zealand Institute of Economic Research (NZIER) showing businesses are no longer confident the domestic economy will protect them against a rising kiwi and poor global economy.

A higher currency cuts exporters' returns while also lowering the cost of imports.

Inflation is tipped to edge down to about 2 per cent in the next nine months, partly because of the exchange rate and the external environment including economic woes in the US and a looming war with Iraq.

At the same time, the New Zealand economy is expected to slow down, with growth easing to about 2.5 per cent from current levels around 4 per cent.

New Zealand's benchmark interest rate is higher than the United States' 1.25 per cent, Britain's 4 per cent and Australia's 4.75 per cent.

Salomon Smith Barney economist Annette Beacher said today's statement reflected the Reserve Bank's neutral bias. She expected the OCR to remain unchanged for the first half of the year, because there was as much chance of economic growth exceeding expectations as there was of the currency remaining at current levels.

"We note the complete absence of reference to the international economic environment, threat of war with Iraq etc."

Westpac currency analyst Jonathan Bayley said in a commentary that the debt market, which rallied on the release, may now price in a higher probability of easing.

UBS chief economist Robin Clements told Reuters that the bank had tilted more towards the possibility of lower rates than expected.

"But I think it was interesting that they made the comment that the domestic economy has been surprisingly strong still and that's where the risks are: that housing, labour market still spills over into inflation which might delay the easing day," he said.

Several bank economists told Reuters they expected June to be the month for the first interest rate cut, rather than March.

- NZPA