12 March 2015

RBNZ holds interest rate at 3.5 per cent

The Reserve Bank is leaving the official cash rate on hold and has promised a “period of stability” for up to two years.

And Reserve Bank governor Graeme Wheeler again said the dollar was too high and needed to see a “substantial” fall.

The bank on Thursday left the rate (OCR) at 3.5 per cent, and has clearly moved to the sidelines, with interest rates set to stay low much longer than expected.

The monetary policy statement continued the “neutral” line on interest rates set in January - even though inflation was expected to fall to “around zero” in the March quarter, and stay low for the rest of the year.

ASB Bank chief economist Nick Tuffley said he expected the Reserve Bank to remain on hold “for the foreseeable future”, but with a 25 per cent chance of a rate cut in the next six months.

Westpac chief economist Dominick Stephens said it was a “make no mistake” policy statement - the Reserve Bank is on hold, with projections for 90 day interest rates flat all the way out until 2017.

TD Securities highlighted Wheeler’s comment that the central bank had “the luxury to lower interest rates substantially if we have to”.

The Reserve Bank had chosen not to join a list of 18 central banks around the world to cut rates recently, but TD was still expecting about 50 basis points worth of cuts later this year.

The Reserve Bank is looking through one-off low inflation shocks from the slump in oil prices last year.

First NZ Capital economists said a key trigger for a rate cut is evidence of a further sharp fall in domestic inflation expectations.

The dollar initially spiked up about US1c to almost US73c.

Economists said the central bank now accepted the currency would stay higher for longer.


A clear sign of the bank’s “neutral” line came with its outlook for short-term interest rates, which shows no rise for the next two years and is 70 basis points lower in 2017 than predicted in December.

Projections for 90-day bank bill rates have been slashed, with the rate expected to sit at just 3.7 per cent until March 2017.

In the December monetary policy statement the 90-day rate was projected to rise from 3.7 per cent now to 4.5 per cent by the middle of 2017.

Financial markets have been pricing in a 64 per cent chance of a rate cut by the end of this year. The central banks in Australia and Canada have both recently cut rates, supporting the view that the Reserve Bank here might also trim rates.

The Reserve Bank last raised rates in July last year, but since then two and three year fixed term mortgage rates have actually been cut by almost 100 basis points.

Inflation was expected to stay low for the rest of the year, because of the high dollar keeping a lid on import prices, low global inflation and the past falls in petrol prices, the bank said.

Inflation was just 0.8 per cent last year, below the Reserve Bank’s target of 1 per cent to 3 per cent.

Wheeler admitted on Thursday that inflation expectations “appear to have fallen recently”, and said the bank would be closely watching the impact of that on wages and prices, especially for New Zealand-based businesses.

He again said the New Zealand dollar was “unjustifiably high and unsustainable” for the economy.

“A substantial downward correction in the real exchange rate is needed to put New Zealand’s external accounts on a more sustainable footing,” he said.

But he added that the domestic economy “remains strong”.

The big fall in petrol prices last year had lifted households’ buying power and lowered the cost of doing business. World oil prices are about 50 per cent down on their peak levels in the middle of last year.

Lower world oil prices were seen as a positive for global economic growth, but would also reduce inflation in the short-term, at a time when global inflation was “already very low” Wheeler said.

But the OCR would not be cut because of impact of diving oil prices on inflation and neither would they go up when oil prices were expected to rise in 2017.

The bank assumed Dubai oil prices would remain about US$55 a barrel for the next two years before rising towards US$70 a barrel.

Recent petrol-price falls were expected to directly lower inflation by about 0.9 per cent, to about zero in the March quarter, and the direct impact of low oil prices was expected to keep inflation low until the end of the year.

The bank said price-setting behaviour by business was still in line with annual inflation, settling at 2 per cent “in the medium term”, by about the start of 2017.

Meanwhile, jobs growth and the building sector are both strong.

The migration boom was giving the economy a boost and low interest rates were also “supportive”. The housing market was also picking up, especially in Auckland.

But there were also a number of factors working against growth, including the recent drought in some regions, government belt-tightening, lower payouts to dairy farmers, and the high exchange rate acting as a headwind for exporters.

Fonterra’s projected payout of $4.70 a kilogram of milk solids would see farm incomes in the 2014-15 season fall about $6 billion on the previous season. That might see a sharp slowdown in farmer spending.