RB leaves cash rate unchanged because of global storm warnings

By NZPA

Wednesday 14th August 2002

Acting Reserve Bank governor Rod Carr today bowed to the influence of a wobbly world economy and left the Official Cash Rate (OCR) unchanged at 5.75 percent.

This is despite the bank's latest quarterly review of the economy showing the domestic economy bubbling along strongly and core inflation running around 3 percent -- close to the top of the bank's 0-3 percent target.

"We are now in receipt of one of the more serious of the storm warnings issued since the late 1990s when the Asian financial crisis combined with two drought seasons," Dr Carr said in his August Monetary Policy Statement.

There was good news for borrowers. Instead of likely further interest rate rises as signalled in the last Monetary Policy Statement in May, Dr Carr said "that prospect looks less likely".

Instead of predicting 90-day bank bills rising to 7 percent next year, the bank now sees them peaking at 6.25 percent in the first half of next year and falling back to 6 percent by the second half of the year. Banks mainly fund mortgage lending from 90-day bills, charging 1.5-2.0 percentage points above the bill rate.

The bank's projection means business and mortgage lending rates are unlikely to change much for the next 18 months.

The Reserve Bank's decision came hours after the US Federal Reserve decided to leave the Fed Funds rate unchanged at 1.75 percent. It signalled the next move may by an easing as the US economy tilted towards further weakness.

Dr Carr said that since the bank's last review of the cash rate last month, the prospects for the international economy had become "increasingly clouded, with sharp falls in equity markets and heightened investor nervousness in the US and elsewhere".

"Although the New Zealand economy has performed well over the past year, the odds of an international slowdown have increased, which would have adverse consequences for the performance of the New Zealand economy."

Dr Carr admitted it was a tough task to gauge how inflation would be affected by global developments.

The bank forecasts consumer price inflation will stay around 2.5 percent this year and next and then drop to 1.75 percent in 2004 and 2005. But it estimated that core inflation, excluding one-off influences, was running higher than CPI inflation.

Domestic prices had risen across a broad front and this was almost certainly related to the fact that the economy had grown faster than the estimated sustainable growth rate for three years, Dr Carr said.

He said that plausibly the effect of the global wobbles would remove upward pressure on inflation.

"But conversely, the economy may continue to grow at a pace that maintains pressure on resources."

The bank forecasts the economic growth rate will pick up from 3.2 percent in 2002 to 3.5 percent in 2003 before easing back. In May, the bank was forecasting growth next year would be just 2.75 percent. It is still forecasting 2.5 percent growth for 2004.

Dr Carr said immigration, which had been a strong driver of domestic growth, might not fall back quickly.

Export volumes are projected to rise marginally but earnings will fall due to weaker prices. And the slowdown in the external sector will channel through to the domestic sector slowing the recent "frenetic pace".

Dr Carr said the New Zealand dollar remained somewhat undervalued against most currencies but not against the Australian dollar.

On balance, he said that current global developments, recent falls in export prices, a higher exchange rate and the lagged effects of the four previous rate rises were likely to dampen inflation pressures.

Of all the threatening economic developments, the current capital market dislocation had the potential to be the most serious, Dr Carr said.

As well, despite the rosy outlook for the domestic economy, a number of indicators suggested the momentum in the economy was slowing.

"For now, the prudent response is to pause, and to watch and wait," he said.

The New Zealand dollar remained largely unmoved by the decision, easing from US46.11c at 9am to US46.07c at 9.30am.

Most economists said the RB's stance was prudent, but the jury was out on whether interest rates had peaked.

"The rate decision itself was as expected. The comments were a little bit more dovish than we thought. The bank, in its central projections, still says there will be further rate hikes, but they qualify that a lot," said Ulf Schoefisch, chief economist of Deutsche Bank.

Dr Schoefisch felt the peak might have been reached, foreseeing a weakening global situation and signs of softness in the domestic economy. But Westpac economist Paul Conway was less sure that the official cash rate would not move up again.

"The Reserve Bank (is) citing an increase in the currency which is expected to increase further, weak commodity prices, the pulse from exports seems to be waning and of course the global scene is a bit shakier than what it was last time around," he noted.

"However offsetting those risks, the weak world may not influence New Zealand inflation to the extent that they think, so basically the Reserve Bank are in wait, watch and worry mode.

"It doesn't (alter our track going forward). The 90-day track in that document peaks at 6.25, which is where we expect to see the OCR peak. So we think there's more increases in the OCR down the track -- so on hold for the meantime but the next move in interest rates will be up."

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