March meeting: Drought, high dollar trump housing bubble as Wheeler holds OCR at 2.5%

Reserve Bank governor Graeme Wheeler held the official cash rate at 2.5 percent, as expected, saying the benchmark rate is not expected to move this year amid an uneven economic recovery. The kiwi dollar dropped on the news.

"The overvalued New Zealand dollar is undermining profitability in export and import competing industries, and worsening drought conditions are creating difficulty in much of the country," he says. "At this point we expect to keep the OCR unchanged through the end of the year."

The central bank expects the 90-day bank bill, often seen as a proxy for the OCR, to start increasing in June next year, before accelerating in 2015 and rising to 4 percent the following year. It had previously projected the rate staying on hold until December this year, rising to 3.3 percent in March 2015.

Traders see 22 basis points of cuts over the next 12 months, based on the Overnight Interest Swap curve.

The New Zealand dollar fell to 82.13 US cents after the statement from 82.60 cents immediately before. It fell to 79.66 Australian cents from 80.13 cents.

Faster than expected

The economy grew faster than expected through the tail end of last year, underpinned by the Canterbury rebuild, and that stronger domestic demand is seen as creating medium-term inflationary pressures, even as consumer prices remain subdued in the foreseeable future, the bank says in the monetary policy statement.

"Monetary policy settings must balance this low near-term inflation outlook and concerns about the exchange rate and weak labour market, against increasing signs that output will accelerate and inflationary pressures will pick up." 

New Zealand food prices fell 0.3 percent last month, led by seasonally cheaper fruit and vegetables and discounted meat, according to government figures published yesterday.

Food prices account for about 19 percent of the consumer price index, which was tracking below the central bank's target 1 percent to 3 percent band in the December quarter at 0.9 percent.

The bank sees the annual pace of inflation staying at 0.9 percent until the September quarter this year, rising the mid-point of its band in latter half of 2015. Medium-term pressures are expected to come in the housing and construction sectors, with the risks skewed to the upside, it said.

Local property prices rose 7.6 percent last month on increasing sales numbers, according to Real Estate Institute figures. New Zealand's property market gains have been driven by a lack of supply in its biggest city, Auckland, and as the Canterbury rebuild gets underway.

"House price inflation is increasing and the bank does not want to see financial stability or inflation risks accentuated by housing demand getting too far ahead of supply," Mr Wheeler says.

The Reserve Bank estimates house prices increased in real terms at an annual pace of 6 percent last year, and will rise 6.2 percent and 3.6 percent this year and the next.

"There is considerable uncertainty around these projections given the nature of supply and demand imbalances in the regional housing markets," the bank says. "We will closely monitor house prices for any signs of feed-through into consumer price inflation."

The bank expects New Zealand's economy to grow at an annual pace of between 2 percent and 3 percent in the coming years on the $30 billion Canterbury rebuild and lift in residential investment.

In the December forecast it projected annual growth of between 2.5 percent and 3 percent over the next two years, largely on the back of the Canterbury rebuild.

That growth will be hampered by the drought across much of the North Island, which is sapping the tail-end of the agricultural production season, and the government's spending cuts which will amount to 3.2 percent of gross domestic product over the next four years.

The governor has been on the campaign trail in recent weeks, publishing a discussion document on planned macro-prudential tools, outlining his views on the currency to manufacturers and promising the bank will deliver more publicly staged speeches giving its opinion on things.

New Zealand's OCR has been on hold for a record 16 meetings since Wheeler's predecessor, Alan Bollard, sliced half a percentage point in March 2011 as insurance against the impacts of the Canterbury earthquake that levelled the country's second-biggest city.

(BusinessDesk)