RBNZ holds OCR at 2.5% and says will keep it there until second half of 2010 (Update 2)

Reserve Bank Governor Alan Bollard has held the Official Cash Rate at its record low of 2.5% and has pledged again to keep it there until the second half of 2010. (Update 1 includes fall in NZ dollar to 71.95 US from 72.7 USc before OCR announcement. Update 2 includes comments from ASB economist Jane Turner and wholesale interest rates falling 10 basis points). Bollard's decision not to budge on the "˜latter part of 2010' forecast for a rate hike surprised many in the markets who had priced in rate hikes from early 2010. Banks have been increasing their fixed mortgage and term deposit rates in recent weeks to reflect expectations in wholesale interest rate markets of OCR hikes from early 2010. The New Zealand dollar dropped to 72.7 USc ahead of the announcement and dropped to 71.95 USc by late morning. Wholesale interest rates dropped around 10 basis points after this rates outlook surprise. Banks now face a tough choice to drag mortgage and deposit rates down again if wholesale rates fall further. However, they may be forced to leave both at current levels given hot competition for term deposits and the Reserve Bank's own direction to banks to fund their borrowing locally through such term deposits. Bollard argued in the statement below that forecast inflation remained within the bank's 1-3% target band and tighter fiscal policy would reduce the heavy lifting he would have to do with monetary policy tightening.

"The forecast recovery in economic activity is based on fiscal and monetary policy continuing to provide substantial support for the economy. We think such support remains appropriate. Further ahead, removing some of the current fiscal stimulus is likely to reduce the work that monetary policy will otherwise need to do," Bollard said. "In contrast to current market pricing, we see no urgency to begin withdrawing monetary policy stimulus, and we expect to keep the OCR at the current level until the second half of 2010," he said. Bollard also lamented again the risk that New Zealand economic imbalances would worsen as export growth stalled and domestic housing-led growth picked up. "The current composition of growth continues to raise questions about its sustainability. These concerns would intensify if credit growth began to propel stronger domestic demand." My view - Alan's big flick pass Alan Bollard performed the monetary policy equivalent of a flick pass this morning. Dan Carter, if he was a monetary policy type, would have been proud. It was a deft exercise in shifting responsibility for rebalancing and slowing the economy across the street from the Terrace to the Beehive. Here's how he did it. Firstly, Bollard announced he would keep the Official Cash Rate (OCR) at a record low of 2.5% and said any future rate hikes would not happen until the second half of 2010. This surprised many in the wholesale interest rate markets who had already been pricing in OCR hikes from early 2010. It may force some of the banks to reverse course on their mortgage and deposit rate hikes of recent weeks. Secondly, Bollard appeared to transfer some of the responsibility for the coming tightening of policy to the government. "Further ahead, removing some of the current fiscal stimulus is likely to reduce the work that monetary policy will otherwise need to do," he said. Maybe Bollard knows something about the current budget thinking that we don't, but it's a bit of a punt to assume the government will be tightening sufficiently to slow a rebounding economy. Lags between government spending decisions and economic effects are at least as long as for monetary so Bollard must be very confident about his economic telescope. Let's hope he has it turned the right way around. Thirdly, Bollard warned again about the risk of New Zealand's recovery being unbalanced with too much housing-led consumption growth and not enough export-led production growth. But again he seems much keener for the government to fix it than the Reserve Bank. "The current composition of growth continues to raise questions about its sustainability. These concerns would intensify if credit growth began to propel stronger domestic demand," he said. One reason for any strong credit growth to the household sector is the OCR at a record low 2.5%. Bollard has previously said he would much prefer the government to change the tax rules around housing investment to help this rebalancing. Like any good first five, Bollard can rightly say one of his jobs is to "˜spread it wide'. He can also rightly say his sole task is focusing on inflation and the inflation outlook is subdued. It's a pity. New Zealand's economy needs some leadership and he is in the perfect position to provide it with a quick chip kick higher of the OCR or a sidestep into tougher capital rules for banks lending to home buyers. Go on Alan, have a go. Your view? We welcome your comments below. Here is the full statement from the Reserve Bank.

The Official Cash Rate remains unchanged at 2.5%. Reserve Bank Governor Alan Bollard said: "There are welcome signs that economic activity is growing again. "Activity in New Zealand's trading partners continued to rebound during the September quarter and financial market sentiment has improved further. However, there remain significant vulnerabilities and challenges to be worked through in many economies. This process could weigh on global growth going forward. "In New Zealand the housing market has reversed some of the decline in prices experienced over the past couple of years and a very gradual increase in household spending appears to be taking place. Government spending is also supporting activity. Business spending, however, remains weak and credit growth is very subdued. "The high level of the New Zealand dollar has limited the scope for exports to contribute to the recovery, and reinforces a bias towards domestic expenditure. After some short term correction it is also likely to see the current account deficit begin to widen in the medium term. "The current composition of growth continues to raise questions about its sustainability. These concerns would intensify if credit growth began to propel stronger domestic demand. "Annual CPI inflation is expected to continue to track comfortably within the target range over the medium term. "The forecast recovery in economic activity is based on fiscal and monetary policy continuing to provide substantial support for the economy. We think such support remains appropriate. Further ahead, removing some of the current fiscal stimulus is likely to reduce the work that monetary policy will otherwise need to do. "In contrast to current market pricing, we see no urgency to begin withdrawing monetary policy stimulus, and we expect to keep the OCR at the current level until the second half of 2010."

ASB Economist Jane Turner comments on the OCR announcement and its implications:

Our expectation remains that the RBNZ will start lifting the OCR earlier than it continues to suggest (but also later than markets have been pricing in). We expect a 50bp hike in April. Much of the statement appeared aimed at tempering market expectations that have built in rate hikes from the start of the year. Hence, as in July's statement, there was very little acknowledgement that the NZ economy is looking in better shape than generally expected. The statement is also a little contradictory, in saying rates will remain low until the second half of next year yet expressing concern that credit growth might trigger stronger domestic spending. In other words, the RBNZ is saying it intends to keep interest rates low but doesn't want anyone to borrow more money. That juxtaposition, and likelihood of continued demand for housing, will increasingly challenge the RBNZ. We expect that the ongoing recovery in the domestic economy will trigger an earlier start to OCR increases than today's statement suggests.