RB tempers rate cut expectations

Reserve Bank governor Alan Bollard left interest rates unchanged today, as expected, but also attempted to dampen expectations that a rate cut is imminent.

While the New Zealand dollar has risen further since the central banker’s last statement in January, "so far, evidence of reduced inflation pressures has not been forthcoming," Bollard says in his latest Monetary Policy Statement.

"The domestic economy has been more robust than we thought. Rapid population growth, rising employment and the earlier strength in the export sector have fuelled strong household consumption and supported higher residential investment and housing market activity," he says.

With the economy running near capacity and strong demand for labour, "inflation in industries serving the domestic economy is relatively high at around 4%."

While Bollard expects inflation will fall over the next few quarters to settle comfortably within his zero to 3% target range, "we do not yet have sufficient certainty about this medium-term path of inflation to warrant a cut in interest rates now."

The June 90-day bank bill futures rose about 6 or 7 basis points to 5.46% immediately after the statement was released, although that level still suggests the market thinks a 25 point interest rate cut is coming. The official cash rate is currently 5.75%.

"I think they (the Reserve Bank) wanted to take a little bit of the euphoria out of the market," says UBS Warburg chief economist Ulf Schoefish.

Bollard is certainly not ruling out a rate cut: "When we see reduced pressure on resources and medium-term inflation, then there may be scope for a cut in the OCR later in the year," he says.

ASB Bank chief economist Anthony Byett says there will undoubted be a rate cut soon if the global outlook deteriorates markedly in the next few weeks, but it’s just as possible that the global outlook will improve.

Byett notes that although the central bank hasn’t changed its forecasts markedly, it does expect a very strong building market and very strong imports, suggesting continued high domestic consumption.

The statement says that continued strong immigration and the recent sharp acceleration in housing consents "suggests that residential investment activity may be sustained at higher levels for some time."

But it also notes that unlike in the housing boom in the mid-1990s, growth in household debt has been relatively muted. "Households appear to have been more reluctant to increase debt-to-income rations than in the past," it says, adding that the rise in activity this time is being financed largely from higher incomes.

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