Reserve Bank holds OCR at 2.25%

The Reserve Bank has opted to keep the official cash rate on hold at 2.25%, indicating more cuts could be on the way.

Reserve Bank governor Graeme Wheeler says although there had been a “modest recovery” in commodity prices in recent months “the global economy remains weak despite  stimulatory monetary policy and significant downside risks remain.”

He says global financial market volatility has abated and the outlook for global growth appears to have stabilised after being revised down successively over recent quarters.

Mr Wheeler says domestic activity continues to be supported by strong net immigration, construction, tourism and accommodative monetary policy. 

“The exchange rate is higher than appropriate given New Zealand’s low export commodity prices.”

In the weeks leading up to the Reserve Bank’s OCR call, the kiwi dollar rose close to 4c against the greenback as investors priced out the chance of a rate cut today.

The kiwi jumped as high as 71.16 US cents, recently trading at 70.86 cents from 70.18 cents immediately before the release. 

As of yesterday, the market was pricing in a 32% chance of a rate cut. Back in early May, that number was more than 80%, before dropping to 52% a week later.

“Together with weak overseas inflation, this is holding down tradables inflation. A lower New Zealand dollar would raise tradables inflation and assist the tradables sector,” Mr Wheeler says.

Mr Wheeler says Auckland house prices remain a concern, and other regions are adding to financial stability concerns.

“Auckland house prices, in particular, are at very high levels, and additional housing supply is needed.”

The central bank faces a dilemma in setting interest rates to influence inflation. Keeping rates high boosts the kiwi dollar, which keeps imported inflation in check, while lower rates mean cheaper mortgages, which could further inflame the housing market.

As expected, Mr Wheeler outlined low inflation as a concern.

“Domestically, the main uncertainties relate to inflation expectations, the possibility of continued high net immigration, and pressures in the housing market.”

The Reserve Bank is an inflation-targeting central bank – it has a mandate to keep inflation between 1-3% with a target of 2%.

The Reserve Bank is a long way from achieving this inflation target, with consumer price inflation (CPI) rising just 0.2% quarter-on-quarter in April and 0.4% annually.

And it looks like it may be a long time until inflation gets anywhere close to 2%.

In the central bank’s most recent quarterly inflation survey, expected inflation for one year out was 1.22% while the two-year figure was 1.62%.

Although this is slightly ahead of the survey’s expectations in the first quarter, experts remain concerned about the lack of inflation in the New Zealand economy.

Mr Wheeler says the low inflation is due to low fuel and other import prices. 

“Long-term inflation expectations are well-anchored at 2%. After falling in recent quarters, short-term inflation expectations appear to have stabilised.

“We expect inflation to strengthen reflecting the accommodative stance of monetary policy, increases in fuel and other commodity prices, an expected depreciation in the New Zealand dollar and some increase in capacity pressures.”

Monetary policy will continue to be accommodative, and “further policy easing may be required to ensure that future average inflation settles near the middle of the target range, he says.

(With reporting from BusinessDesk)

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