OCR unchanged, pick-up in economy may drive early rate hike

Thursday 10th December 2009

Reserve Bank Governor Alan Bollard kept the official cash rate unchanged at a record low 2.5%, as expected, and brought forward the likely timing of interest rate increases, forecasting a faster pace of economic recovery.

"The economy continues to recover, reflecting improved world growth, higher expert commodity prices, increased government spending and housing strength," Bollard said in Wellington today.

He dropped his insistence that rates will stay low until the second half of next year saying the economy was returning to growth.

"Conditions may support beginning to remove the monetary stimulus around the middle of 2010," he said.

The central bank will have to walk a fine line over stoking economic activity without over-egging it as inflation begins to speed up ahead of Bollard's expectations and the housing market continues to show signs of emerging from the lethargy of the past 18 months.

The Reserve Bank's Expectations Survey found respondents see inflation accelerating to a 2.6% annual pace from 2.3% over the next two years. Prices unexpectedly rose in the third quarter, with the Consumer Price Index increasing to an annual 1.7%, according to government data, ahead of the 1.2% pace forecast by the RBNZ.

"Domestic inflation is proving very stubborn to unwind," ASB economist Jane Turner said in a report before the announcement. "As the local recovery has progressed, the downside risks to the inflation outlook have diminished rapidly."

Before today's statement, traders had been betting the central bank would hike the OCR by 1.63 percentage points in the next 12 months, based on the Overnight Index Swap curve. The scale of expected tightening has declined in the past month as Bollard reiterated the divergence of monetary policy between New Zealand and Australia, where rates have been rising for the past three months.

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