December interest rate cut tipped

Economists are suggesting a softening in Reserve Bank governor Alan Bollard's language could see him deliver mortgage relief to home owners through a cut to the official cash rate by year's end.

Dr Bollard today left the OCR unchanged at 8.25 per cent. Although he said the benchmark interest rate needed to stay there for "a time yet", this was a softening of his March position.

Leaving the OCR unchanged on March 6, Dr Bollard said it needed to stay at 8.25 per cent for "a significant time yet."

"We now expect the Reserve Bank to cut rates in December, rather than early 2009," ASB chief economist Nick Tuffley said.

Westpac chief economist Brendan O'Donovan said Dr Bollard's comments had given the market the green light to price in rate cuts this year.

"However, we still think the market is getting ahead of itself in pricing in cuts as soon as October," O'Donovan added. 

The Reserve Bank has not cut the official cash rate since July 2003 and has hiked it 13 times since then.

Dr Bollard also said today there was "significant" downside risk to future economic activity but upside risks to inflation. The Reserve Bank is tasked with holding inflation between 1 and 3 per cent on average over the medium-term.

The consumer price index for the year to March, released by Statistics New Zealand last week, showed inflation rising 3.4 per cent pushed up by soaring petrol and food prices.

Dr Bollard said, however, that economic activity had weakened since March more than the central bank had expected. He pointed to sharp falls in consumer and business sentiment, which had been exacerbated by tighter credit conditions.

There had also been a further weakening in the housing market and softer global growth prospects. Furthermore, international financial market turbulence continued to add to an uncertain environment. To top it all off the dry local summer was also weakening short-term growth prospects.

However, the labour market remained strong and New Zealand's key international commodity prices, notably dairy prices, remained strong. Government spending plans and the potential for personal tax cuts were also expected to limit the economic slowdown.

"The weaker economy will, over time, ease accumulated pressure on resources and reduce inflation pressure. However, short-term inflation is likely to remain persistently high, due in large part to repeated increases in food and energy prices," Dr Bollard said.

He also pointed to an inflationary risk stemming from higher wage demands as people reflected on short-term price shocks rather than adjusted to changing economic conditions. The Engineering, Printing and Manufacturing Union, the country's biggest trade union, last week said companies could face demands from workers for higher wages as food and fuel prices rose and housing became less affordable.

Dr Bollard added that the "persistently strong" New Zealand dollar was a further risk to the outlook. Although this helped moderate headline inflation, it remained a drag on export growth.

- © Fairfax NZ News