RBNZ to keep OCR at 2.5 percent through 2013 amid housing-currency tension

Thursday 13th June 2013

Reserve Bank governor Graeme Wheeler kept the official cash rate at 2.5 percent and expects to stay put for the rest of the year as he balances the competing tensions of an "overvalued" currency and an overheating property market. The kiwi fell after the statement.

The central bank affirmed its expectation the key interest rate will stay on hold this year, while saying it stands ready to hike rates if rising house prices spur another property bubble, or cut rates if the kiwi dollar continues to appreciate. The bank ramped up its projection for the trade-weighted index by about 200 basis points for the currency until March 2016.

"Despite having fallen over the past few weeks, the New Zealand dollar remains overvalued and continues to be a headwind for the tradables sector, restricting export earnings and encouraging demand for imports," Wheeler said in a statement. Still, "as previously noted, the Reserve Bank does not want to see financial or price stability compromised by housing demand getting too far ahead of the supply response."

Wheeler has to steer monetary policy in a world where inflationary pressures are weak and New Zealand's economy is a relative outperformer. Raising interest rates could re-ignite a kiwi dollar that the bank has used its own funds to weaken in recent months, though it would also take some of the steam out of a housing market driven by supply shortages in Auckland and Christchurch that threatens to ignite inflation.

"Monetary policy has been in a bind for some time, trapped between rising house prices and the high exchange rate," Dominick Stephens, Westpac Banking Corp chief economist for New Zealand, said in his MPS preview. He expects "a slightly more hawkish tone" in next week's MPS, given that "economic buoyancy has become more intense" in recent months.

The New Zealand dollar fell to 79.35 US cents from 79.83 cents immediately before the statement. The TWI fell to 73.85 from 74.26.

Wheeler said annual inflation is expect to rise towards the mid-point of the central bank's target 1 percent to 3 percent band, even as the currency keeps a lid on imported prices. Consumer prices rose at an annual pace of 0.9 percent in the first three months of the year, the third quarter in a row where it's been below the central bank's target of between 1 percent and 3 percent.

The central bank forecasts the annual consumer price index to return to the band in September of this year, rising above 2 percent in June 2015, when interest rates are tipped to start increasing as domestic demand spurs inflationary pressures.

The central bank expects the 90-day bank bill, often seen as a proxy for the OCR, to start rising in June next year, with a slightly steeper curve starting in 2015, before reaching 4.2 percent in March 2016. It had previously projected the rate unchanged until June next year, before accelerating in 2015 and rising to 4 percent in 2016. Before the announcement, traders priced in 24 basis points of increases in the coming year, according to the Overnight Index Swap curve.

The Reserve Bank sees house price inflation is continuing to build, with prices up 9 percent in the three months ended April 30 from the same period a year earlier. While that's expected to rise modestly through the rest of this year before abating in 2014, it's still a key risk for the regulator. The bank's projections assume it hasn't used its new macro-prudential tools.

Housing Minister Nick Smith said government plans to free up housing supply aims to trim "super profits" from land banking, which is making property unaffordable in Auckland. Real Estate Institute figures yesterday showed national stratified house prices have climbed 8.7 percent in the year ended May 31, with the number of sales up 7.1 percent from a year earlier.

Wheeler said the economy is being driven by increasing consumption and the Canterbury rebuild gathering pace, which is get further impetus from residential construction in Auckland. The bank trimmed 0.5 percent from its forecast for gross domestic product this year as the impact of the drought comes to bare. It sees annual growth of 2.8 percent in March 2014, accelerating to 3.3 percent in the March 2015 year and 3.1 percent the following year.

That compares to the Treasury's budget forecast of 2.4 percent in 2014 before rising to 3 percent and 2.6 percent the following two years.

New Zealand's OCR has been on hold for a record 19 meetings since Wheeler's predecessor, Alan Bollard, sliced half a percentage point in March 2011 as insurance against the impacts of the Canterbury earthquake that levelled the country's second-biggest city.

BusinessDesk.co.nz

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