Reserve Bank holds interest rate at 2.5pc

20:21, Dec 05 2012

The Reserve Bank has left the official cash rate unchanged at 2.5 per cent.

New governor Graeme Wheeler said economic growth slowed in recent months and inflation has been low, while unemployment was rising.

“On balance, it remains appropriate for the OCR to be held at 2.5 per cent,” he said in today’s Monetary Policy Statement.

Despite a sluggish economy recently, in the next two years growth is expected to pick up to between 2.5 per cent and 3 per cent a year. The global outlook remained soft but was less threatening than earlier in the year.

Repairs and rebuilding in Canterbury were gathering pace and the housing market was getting stronger, especially in Auckland. The Reserve Bank is now expecting about $30 billion of quake-related work in Canterbury, but over an extended period.

Lower funding costs for banks and increased competition had seen mortgage interest rates fall from already low levels.

The Reserve Bank warned that if the housing market continued to gather steam there was a risk of a stronger pick up in household credit and rising house price inflation. Higher house prices and greater household spending would likely lead to higher inflation than is currently projected.

“All else equal, such a development could necessitate a higher official cash rate,” the bank said.

But government belt-tightening and cautious spending by households and businesses were offsetting factors for the economy.

The high New Zealand dollar remained a “significant headwind” Wheeler said, restricting export earnings and encouraging demand for imports.

But the overall outlook was for stronger domestic demand and so “excess capacity” in the economy would be eliminated by the end of next year.

That was expected to see inflation rise gradually towards the 2 per cent mid-point of the central bank’s target range. Latest annual inflation was extremely low at 0.8 per cent, just below the bottom of the target range.

The bank was keeping close watch for any further “moderation” in inflation and was mindful of recent surprises with high unemployment at 7.3 per cent and low inflation.

But Wheeler also warned that with the reconstruction pick-up in investment “now clearly underway” the bank would also keep watch for higher inflation than presently assumed.

“On balance it remains appropriate for the OCR to be held at 2.5 per cent,” Wheeler said.

The cash rate has been held at the historically low rate since March 2011, when it was dropped to help counter the impact of the Canterbury earthquake.

The bank’s projection for 90 day bank bills remains flat for all of next year, before gradually turning up early in 2014, but only reaching 3.3 per cent by early 2015, compared with about 2.7 per cent recently. The track for 90 day rates is slightly flatter than in September’s Monetary Policy Statement.

While unemployment was up to 7.3 per cent in official figures the Reserve Bank said that was overstating the worsening picture and that the economy continued to expand, albeit slowly.

Housing investment is projected to be up almost 20 per cent in the year to March 2013, jumping 29 per cent in the following March year as the Canterbury rebuild ramps up.

The Reserve Bank is also projecting economic growth of 2.2 per cent in the year to March 2013, and then 2.8 per cent in the following March year.

Unemployment is expected to fall from 7.1 per cent in March 2013, to 5.9 per cent in the March quarter in 2014.

But the Reserve Bank holds out no relief in sight for exporters, with the New Zealand dollar expected to remain high for the next few years. That would continue to dampen export earnings and encourage imports with import volumes expected to remain high.

Watch Wheeler's presentation here.