Steady as she goes….

Date: 11th June 2011

Official Cash Rate goes unchanged: The Reserve Bank of New Zealand (RBNZ) has left the official cash rate (OCR) unchanged at 2.5 percent, but its accompanying statement suggested concerns about the risk of inflation growing.

In his main statement today RBNZ Governor Alan Bollard said indicators of capacity usage and core inflation suggested underlying inflation remained constrained.
As growth in gross domestic product picked up, underlying inflation was expected to rise, with a gradual increase in the OCR over the next two years required to offset that, Dr Bollard said.

“The pace and timing of increases will be guided by the speed of recovery, but for now the OCR remains on hold.” But the Reserve Bank’s monetary policy statement (MPS) noted surveyed inflation expectations and indictors of firms’ pricing intentions had picked up recently.

“It would be of concern if the recent pick up and relatively high level of surveyed inflation expectations persisted,” the MPS said.

The RBNZ’s central projection assumed the pick up reflected the current high level of headline consumers’ price index (CPI) inflation, with surveyed expectations therefore likely to moderate over the coming year.

“However, the increase could also represent a more embedded increase. Heightened inflation expectations would limit the scope for monetary policy to absorb any upside inflation surprises,” the MPS said.

Core inflation had risen in recent quarters, consistent with some rise in capacity pressures. One approach, adjusted to exclude the estimated effect of the rise in the rate of GST in the December quarter, pointed to core inflation above 2 percent for each of the previous two quarters.

Headline inflation was elevated, with the CPI rising 0.8 percent in the March quarter. A key factor was the October rise in GST, with other factors including increases in the tobacco excise and petrol prices.
The influence of rising food and petrol prices was expected to reduce by the end of the year, allowing for the rate of inflation to fall to well within the target band, the MPS said.

The RBNZ’s target was to keep CPI inflation to between 1 percent and 3 percent on average over the medium term.

Dr Bollard said the economic outlook had improved in the past three months. It appeared the negative confidence effect of the Christchurch earthquake in February on economic activity throughout the rest of the country had been limited.
Commodity prices remained “very strong” and firms expected to increase their hiring and capital investment, Dr Bollard said.

Reconstruction in Canterbury was projected to add about 2 percentage points to GDP growth over 2012, and boost the level of activity for several years after that.
In March RBNZ cut the OCR by 50 basis points, to lessen the economic impact of Christchurch and “guard against the risk of this impact becoming especially severe”.

Today’s MPS said an improving profit outlook, particularly for export-oriented firms, was one factor that would likely see business investment rise from current low levels. Capital goods were also likely to be relatively cheap, given the above-average level of the exchange rate.

Households were not expected to increase spending quickly, having accumulated a significant amount of debt in past decades, the MPS said.

Consistent with subdued consumption, house prices were likely to increase at or below the rate of inflation in the next few years. Statistical models suggested house prices continued to be overvalued when compared to such measures as nominal GDP or rental yields.



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