Central bank forecast to stick with 2.5pc rate

17:00, Apr 21 2013

The Reserve Bank will sit on the fence and hold interest rates at 2.5 per cent this week, caught between a high New Zealand dollar and a strong housing market, economists say.

The one-page April review of official interest rates is due out on Wednesday, a day earlier than usual because of the Anzac Day holiday on Thursday.

The central bank is expected to hold rates this week and indicate that they would remain on hold till the end of the year, with inflation benign at less than 1 per cent in the past year and a widespread drought denting economic growth.

ASB Bank economists expected official interest rates to remain on hold till March 2014.

The currency was about US84.5c on Friday, not far off a recent peak above US86.7c. The exchange rate is about 4 per cent higher than the Reserve Bank assumed in March.

House prices are up about 8 per cent in the past year, driven by hot markets in Auckland and Christchurch.


But at the same time, official inflation remains extremely low, at 0.9 per cent up for the year to March and is expected to remain below 1 per cent, the bottom of the Reserve Bank's target band, for the rest of the year.

The overvalued dollar is holding down import prices, but also making life tougher for exports. A higher dollar suggests the Reserve Bank will hold interest rates lower for longer, even though the lowest mortgage rates in 50 years are boosting the housing market.

The tension between the high currency and a stronger housing market has become worse since March.

While the Reserve Bank has held official interest rates at 2.5 per cent for two years, Westpac Bank chief economist Dominick Stephens said the central bank now seemed to be "sitting on the fence" and that was becoming uncomfortable.

On one side, the Canterbury rebuild and rising house prices were producing rapid growth, which could see inflation rise.

On the other side, inflation was being kept down because of the high dollar, and the currency could rise even more.

In the March Monetary Policy Statement, the Reserve Bank said if the currency stayed high, official interest rates could be cut.

But the Reserve Bank has also recently said if the housing market stayed strong and provoked higher consumer spending, official rates could go up sooner.

"The central bank faces two diametrically opposed risks," Stephens said.

The economic picture is looking rosier, with growth in the December quarter better than expected at 1.5 per cent and business confidence is healthy.

At the same time the farm sector has been hit by drought, which could wipe up to $2 billion off the economy, though a huge leap in world dairy prices, up 50 per cent in two months, will help offset the loss in milk production.

The overall drought impact will dent but not crush growth this year, knocking from 0.5 to 1 per cent off GDP, though it is likely to be toward the bottom of that range.