Reserve Bank leaves rates unchanged

As most expected, Reserve Bank governor Alan Bollard has left the official cash rate (OCR) unchanged, but has warned that small increases may be needed next year to control inflation.

Bollard says that although the domestic economy is growing strongly "and some key asset prices appear to be moving beyond their sustainable level," inflation has fallen over the last year because of falling import prices.

Bollard’s again issued a particular warning for the housing market. "The strong activity, especially in housing and construction, spurred by rapid population growth and high consumer confidence, has produced quite intense inflation pressures in parts of the domestic economy."

The wholesale interest rate markets, which had been pricing in about a 50% chance of a rate rise today, reacted sharply, the 90-day bank bill rate dropping about 12 basis points to 5.30%. The New Zealand dollar fell about 20 basis points against the US dollar and about 40 basis points against the Australian dollar.

The latter reflects the contrast between our central bank’s decision and the Reserve Bank of Australia’s move yesterday to raise its OCR to 5.25%.

It’s the first time in more than three years that Australia’s OCR has been higher than New Zealand’s.

Craig Ebert, treasury economist at Bank of New Zealand, says he had thought the bank’s decision was a close call.

"They’re in a very sticky situation. They’ve got some very strong bits of data to suggest they shouldn’t have interest rates on the stimulus side of neutral, which is where they are. On the other hand, they have the tension of the exchange rate having risen considerably in the last month," Ebert says.

In the last three months, the New Zealand dollar has soared from about 56 US cents to near 65 cents.

Nick Tuffley, an economist at Westpac Bank, says while today’s statement might be read as being on the dovish side of expectations, the central bank’s forecasts are still showing rapid rises in rates next year. It expects the 90-day bank bills will be at 5.75% by the middle of this year and that even with the very strong currency factored in, inflation will still reach 2.75% by 2005.

"It’s still likely we will see a rate rise in January and definitely by March," Tuffley says.

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