Bollard pointing to first rate hike in December

The Reserve Bank has left interest rates unchanged, with its latest monetary policy statement (MPS) appearing to firm up the likelihood the first hike will be in December.

While Reserve Bank of New Zealand (RBNZ) Governor Alan Bollard today said indicators of capacity usage and core inflation suggested underlying inflation remained constrained, the MPS noted surveyed inflation expectations and indicators of firms' pricing intentions had picked up recently.

"It would be of concern if the recent pick up and relatively high level of surveyed inflation expectations persisted," the MPS said.

The RBNZ left the official cash rate (OCR) unchanged at 2.5 percent, with Dr Bollard saying a gradual rise in the OCR during the next two years would be needed to offset an expected rise in underlying inflation as gross domestic product picked up.

"The pace and timing of increases will be guided by the speed of recovery, but for now the OCR remains on hold."

The RBNZ's target is to keep consumers' price index (CPI) inflation to between 1 percent and 3 percent on average over the medium term. Indicators are now pointing to core inflation above 2 percent for each of the previous two quarters.

BNZ head of research Stephen Toplis said the RBNZ had woken up to the fact that the economy was on a relatively firm footing, despite the Christchurch earthquake in February.

"And with that firm footing comes heightened inflation risk," Mr Toplis said.

For all intents and purposes the RBNZ had said its central scenario had the first rate hike in December. A September hike could not be ruled out, while a 50 point rise in December was not inconceivable.

That said, BNZ was leaving unchanged its forecasts of 25 point rises in December, January and March, Mr Toplis said.

The RBNZ's policy outlook relied on three key assumptions -- that construction cost inflation would be subdued compared to the peak in the middle of last decade, households would continue to focus on reducing debt, and recent rises in surveyed inflation expectations would be short lived.

"In our opinion, there is a very real chance that one or indeed all of these assumptions are violated," Mr Toplis said.

RBNZ officials had highlighted raised inflation expectations as a major concern and expressed the view that if the expectations did not fall quickly the RBNZ would "get very nervous indeed".

Westpac chief economist Dominick Stephens said the RBNZ had "significantly" altered its stance on future monetary policy. It was firmly focused on an upcoming surge in economic activity, combined with strong export commodity prices, that together would put upward pressure on inflation.

Westpac now expected the first hike of 25 basis points to the OCR would be in December, rather than January as it expected previously.

Deutsche Bank also now expected the most likely next move to be a 25 basis point hike in December, rather than the 50 basis point lift in March it had previously factored in.