Bollard keeps OCR at 2.5 percent, cites weak trading partners

Thursday 13th September 2012

Reserve Bank governor Alan Bollard kept the official cash rate at 2.5 percent at his final review of monetary policy, saying the weak outlook for the country's trading partners threatens economic growth and the strong kiwi dollar is hurting exporters and local manufacturers.

"Several euro-area economies are in recession and Chinese growth has slowed," Bollard told a briefing in Wellington. Signs of life in the domestic economy were being offset by the government's plans for fiscal consolidation and a strong currency that "continues to undermine export earnings and encourage substitution toward imported goods and services," he said.

The central bank trimmed its forecast for the 90-day bank bill rate, often seen as a proxy for the OCR, with the rate on hold until December next year and rising to 3.3 percent in March 2015. It had previously seen the rate unchanged at 2.7 percent until June 2013, before peaking at 3.4 percent in March 2015.

Bollard has kept the benchmark interest rate on hold for a record 12 meetings, since he sliced half a percentage point from the OCR in March last year as insurance against the effects of the Canterbury earthquake that levelled the nation's second-biggest city.

The bank hiked its forecast for the currency on a trade-weighted basis, and doesn't see it falling below 70 until the June quarter in 2014. It was previously picking it to drop into the high 60s in the September quarter of the current year.

The kiwi has waxed and waned with equity market sentiment this calendar year, and has been supported by "rising interest rate differentials between New Zealand and the five countries that make up the TWI and upward pressure on soft commodity prices," the bank said.

The Reserve Bank is under little pressure to move the rate, with the consumer price index right at the bottom of the central bank's 1 percent-to-3 percent target band, and few expectations the rate will rise much in the foreseeable future.

Bollard said underlying inflation recently dipped below 2 percent, and "is expected to settle near the mid-point of the target range of the medium term."

New Zealand's AA-rating was affirmed by Fitch Ratings this week, with the agency citing the nation's strong record of fiscal and monetary policy management. Fitch said New Zealand's weaknesses lay in its private level of indebtedness, and it didn't expect the government to reach its targeted 2015 fiscal surplus.

The bank sees faster economic growth in the 2013 and 2015 March years at 2.4 percent and 2.2 percent, while 2014 expansion will be a touch softer than previously forecast at 2.9 percent.

"Population growth, reconstruction in Canterbury and regulator maintenance and repairs are expected to drive a substantial pick-up in construction sector activity over the next few years," the bank said. "Fiscal consolidation, which will dampen growth in both public and private consumption expenditure, is expected to offset this pick-up."

Bollard's announcement comes after the German Federal Constitutional Court ruled it was legal for the country to participate in the 200 billion euro European Stability Mechanism. The fund was set up to help bail-out overly indebted nations in the euro-zone, and has helped allay investors' fears the region will plunge into sovereign debt crisis.

Traders are betting the bank will cut the rate by 8 basis points over the next 12 months, according to the Overnight Index Swap curve. Because the bank moves rates in lots of 25 basis points, that indicates a chance of a rate cut if the global economy sours.

"At the time of writing there was a slight easing bias priced into the OIS curve, reflecting a small probability of the Reserve Bank cutting the OCR within the next six months," the bank said. "From about March 2013 onwards, a modest chance of the Reserve Bank tightening policy is priced in."

Bollard steps down when his second five-year term expires on Sept. 25 and will be replaced by former World Bank executive Graeme Wheeler.

BusinessDesk.co.nz

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