RBNZ keeps OCR at 2.5 percent, will mull hikes if housing, construction spurs wider inflation

Thursday 25th July 2013

Reserve Bank governor Graeme Wheeler kept the official cash rate at 2.5 percent as consumer price increases remain muted, though he will mull a hike if the momentum in housing and construction spur broader inflation.

"The extent of the monetary policy response will depend largely on the degree to which the growing momentum in the housing market and construction sector spills over into inflation pressures," Wheeler said in a statement. "Although removal of monetary stimulus will likely be needed in the future, we expect to keep the OCR unchanged through the end of the year."

In its June forecasts, the Reserve Bank expected 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. Traders are pricing in an increase of 39 basis points over the coming 12 months, according to the Overnight Index Swap curve.

"We don't expect a lot of change in the RBNZ's outlook assessment relative to the June monetary policy statement," said ASB chief economist Nick Tuffley, in a preview.

A weaker currency and higher dairy prices mean the medium term inflation outlook has probably been revised up, though the bank was likely to repeat its view that it expects "to keep the OCR unchanged through the end of the year," Tuffley said.

Wheeler has had to steer monetary policy in an environment where inflation has been below the bank's target band of between 1 percent and 3 percent as a strong currency keeps imported prices down, while balancing that against building pressures in the Auckland housing market and a massive reconstruction effort in Canterbury.

He took another dig at the Auckland and Canterbury housing markets, which have been outpacing the rest of the nation amid a shortage of supply, reiterating the bank "does not want to see financial or price stability compromised by housing demand getting too far ahead of the supply response."

The bank is currently considering the introduction of macro-prudential tools to limit the level of high loan-to-value ratio home lending as a means to counter the threat of low equity home lending the stability of the banking sector.

Government figures earlier this month showed the consumer price index rose at an annual pace of 0.8 percent in the second quarter, its slowest pace in 14 years, with building price pressures in housing and construction remaining relatively contained.

In its June monetary policy statement, the central bank forecast the annual CPI to return to the band in September of this year, rising above 2 percent in June 2015.

Wheeler said the New Zealand dollar is still high and is dragging on exporters by restricting their earning power and encouraging demand for imported substitutes.

The kiwi dollar averaged 76.55 in the second quarter on a trade-weighted basis, below the Reserve Bank's projected 77.50. The TWI recently traded at 75.31 after the OCR announcement from 75.17 immediately before. The kiwi rose to 79.50 US cents from 79.30 cents.

Wheeler said the domestic economy's recovery is improving across more sectors, albeit in an uneven way.

"Consumption is increasing and reconstruction in Canterbury will be reinforced by broader national recovery in construction activity, particularly in Auckland," he said. "This will support aggregate activity and eventually help to ease the housing shortage."

New Zealand's construction industry will get another boost from the recent swarm off earthquakes in the central North Island, where a 6.5-magnitude quake in the Cook Strait damaged 35 buildings in the capital city, Wellington. The damage has been relatively limited and Credit Suisse has estimated insured losses will be "well below" US$1 billion.

The central bank 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.

BusinessDesk.co.nz

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