UPDATED: Bollard raises OCR, sees moderating path

UPDATED: Bollard raises OCR to 3%, sees more moderate track from here

(BusinessDesk) – Reserve Bank Governor Alan Bollard raised the official cash rate a quarter point to 3% as expected, while predicting a less aggressive path for further increases, given “subdued” domestic demand and a fragile global recovery. The kiwi dollar tumbled half a U.S. cent after the statement.

“While the outlook for economic growth has softened somewhat, it is still appropriate to continue to reduce the extraordinary level of support implemented during the 2008/09 recession,” Bollard said in a statement released in Wellington today. “The pace and extent of further OCR increases is likely to be more moderate than was projected in the June statement.”

Recent data and confidence measures point to an economy that has slowed to a more tepid pace, easing pressure on the central bank to embark on an aggressive tightening cycle. Business confidence weakened for a third straight month, according to the National Bank Business Outlook, with firms seeing smaller profits and reducing plans to hire more workers. Demand in the housing market is weak, net migration is waning and consumers are repaying debt rather than spending.

Bollard’s decision “all makes sense” in the light of the weakening outlook for the domestic economy, said Bank of New Zealand head of research Stephen Toplis.

While the RBNZ was now looking to a lower interest rate path over the next two years or so, there was still a “50/50” chance another rate rise would be announced following the next RBNZ board meeting in six weeks’ time, because of the “extraordinary level of support” that monetary conditions had been affording the economy, he said.

The New Zealand dollar dropped to 72.07 U.S. cents from 72.66 cents immediately before the statement. The trade-weighted index sank to 67.43 from 68.01. The kiwi fell to 80.87 Australian cents from 81.35 cents, having spiked higher yesterday after data showed Australian inflation was a weaker-than-expected 0.6% in the second quarter.

Bollard said today that the kiwi dollar’s appreciation in recent weeks is “inconsistent with the softening in New Zealand’s economic outlook and moderation in our export commodity prices.”

Today’s statement paints a gloomier picture of the global economy than was evident in the June 10 Monetary Policy Statement, when Bollard cited a recovery in trading partner activity, led by Asia, Australia and the U.S. Since then, Federal Reserve chairman Ben Bernanke has said the path of the U.S. economy is “unusually uncertain” and China’s GDP growth has slowed.

Prices of New Zealand commodities such as milk powder have weakened in recent months.

Today’s rate hike was predicted by all 20 economists in a Reuters survey and they expect Bollard will continue to lift the OCR back to more normal levels of 4% to 5%, ending the extraordinary stimulus in place since April last year when he cut the OCR to a record low 2.5%.

The RBNZ resumed raising interest rates on June 10. Since then data has shown the economy expanded 0.6% in the first quarter, less than the bank’s 0.8% forecast.

Near-term economic growth is expected to be “respectable” with elevated manufacturing confidence and growing exports of forest products, Bollard said.

Currently, though, domestic demand is subdued, with households still cautious, retail spending growing only modestly and a weakening housing market which will be exacerbated by a drop-off in migration, he said. Business investment “remains very low” and corporate lending is subdued.

The dilemma for Bollard is to predict how inflationary pressures will have emerged over the next 18 months, with a risk that the short-term effects of increased government levies and imposts, such as the Emissions Trading Scheme, GST hike and ACC charges will feed through into broader inflation expectations.

Inflation is expected to spike to over 5% in the first quarter of 2011 from an annual pace of 1.8% last quarter though Bollard has said he sees little ongoing impact, with the GST increase softened by tax cuts.

“The bank does not expect this price spike to have a lasting impact on inflation,” Bollard said. “However, the price and wage setting behaviour of firms and households will be monitored for evidence of any increase in inflation expectations.”

He said inflationary pressures “are expected to pick up” as the economy grows.
Business surveys shows firms are preparing to raise prices and the extent of second-round impacts isn’t clear yet though in yesterday’s confidence survey, the extent of intended price increases had moderated.

(BusinessDesk)

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