Wheeler keeps interest rates on hold

UPDATED: Reserve Bank governor Graeme Wheeler has kept the official cash rate at 2.25%, in a decision traders had said could go either way while predicting inflation will pick up as the slump in oil prices washes out of the data and capacity pressures start to build in the economy. The kiwi dollar jumped more than three-quarters of a US cent.

"We expect inflation to strengthen as the effects of low oil prices drop out and as capacity pressures gradually build," Mr Wheeler says. "Monetary policy will continue to be accommodative. Further policy easing may be required to ensure that future average inflation settles near the middle of the target range."

Traders had put a 52% chance of Mr Wheeler holding rates unchanged at today's review, whereas most local economists were picking it to stay unchanged. The kiwi jumped to 69.15USc from 68.34c immediately before the statement.

Mr Wheeler has struggled to spur domestic inflation as the resilience of the kiwi dollar and cheap oil keep a lid on prices while being mindful of the impact of low borrowing costs on a buoyant property market.

Mr Wheeler says the kiwi is "higher than appropriate" given the drop in New Zealand's commodity export prices, and "a lower New Zealand dollar is desirable to boost tradables inflation and assist the tradables sector". He also acknowledged there are "some indications that house price inflation in Auckland may be picking up."

Last month Mr Wheeler cut the benchmark rate to a record low to try and prevent weak inflation from embedding into wage and price setting behaviour. That surprised economists after he had earlier said he was able to look through price shocks, calling the focus on the consumers price index a "mechanistic approach."

Inflation is tracking at a 0.4% annual pace, below the 1-3% target band, and the Reserve Bank doesn't see it moving back within the range until December this year. However, an increasing number of firms surveyed by the New Zealand Institute of Economic Research say they intend to raise prices this year, something they've struggled to do in the past.

Mr Wheeler says imports and cheap fuel are keeping headline inflation low, but that annual core inflation is within the bank's target, and long-term inflation expectations are "well-anchored" at 2%. Still, short-term inflation expectations have gone through a "material decline", something the bank had previously noted.

The local economy is still being supported by strong inward migration, construction, tourism and low interest rates, and while dairy prices have increased they are still below breakeven levels for farmers, he says. 

Further complicating matters for Mr Wheeler is the continuation of extraordinary monetary policy among the major central banks, with European and Japanese authorities persisting with money printing programmes, and the US still reluctant to raise rates. The Federal Reserve this morning kept the federal funds rate at between 0.25-0.5% and reaffirmed its path to higher rates is a gradual one.

"Monetary conditions are extremely accommodative internationally, with considerable quantitative easing and negative policy rates in some countries," Mr Wheeler says. "Financial market volatility has eased in recent weeks, but markets continue to watch the policy settings of major central banks."

(BusinessDesk)