RBNZ holds OCR at 2.5%, but Bollard inserts wiggle room for 2010 rate hike

The Reserve Bank has left the Official Cash Rate (OCR) on hold at 2.5%, but has brought forward slightly its expectation of lifting the rate in 2010. Reserve Bank Governor Alan Bollard gave himself some wiggle room by saying that a rate hike was possible around the middle of 2010, which appears slightly earlier than his earlier pledges to keep it on hold until the second half of 2010. Bollard said the economic outlook had improved in recent months, particularly in Australia, China and emerging Asia. But he said there were still risks in the major developed economies where financial sectors were still stressed. Bollard said a tighter budget, higher long term market interest rates and the New Zealand dollar would help keep a lid on inflation, meaning he didn't have to take immediate action to tighten monetary policy. "The economy is being assisted by both monetary and fiscal policy support. As growth becomes self sustaining, fiscal consolidation would help reduce the work that monetary policy might otherwise need to do," Bollard said in a statement. "If the economy continues to recover, conditions may support beginning to remove the monetary stimulus around the middle of 2010," he said. "Recent tightening in financial conditions, driven by a higher exchange rate, increased long term interest rates and a wider gap between the OCR and bank funding costs, reduces the need for more immediate action." Here is the Full Reserve Bank of New Zealand OCR statement issued with its December Quarter Monetary Policy Statement below.

The Official Cash Rate (OCR) remains unchanged at 2.5%. Reserve Bank Governor Alan Bollard said: "The New Zealand economy continues to recover, but there remains considerable uncertainty about the durability of the expansion. "Global activity has continued to rebound. Most obviously, activity in Australia, China and emerging Asia continues to increase and solid growth is expected over the next few years. "The picture is more mixed in the major developed economies. While activity is expanding, sustained growth is not assured. Financial sectors are still impaired in a number of economies and economic activity is still heavily dependent on policy support. "In New Zealand, the economy continues to recover, reflecting improved world growth, higher export commodity prices, increased government spending and housing strength. A key uncertainty is the extent to which higher house prices are eventually reflected in increased consumer spending. At this point credit growth remains subdued, suggesting households are being relatively cautious. "While business confidence has improved, actual business spending remains weak. In addition, the high level of the New Zealand dollar has limited scope for exports to contribute to the recovery. After some short term correction, the current account deficit is expected to widen in the future. "Annual CPI inflation is expected to remain below 2% until early 2011 and track within the target range over the medium term. "The economy is being assisted by both monetary and fiscal policy support. As growth becomes self sustaining, fiscal consolidation would help reduce the work that monetary policy might otherwise need to do. "If the economy continues to recover, conditions may support beginning to remove the monetary stimulus around the middle of 2010. Recent tightening in financial conditions, driven by a higher exchange rate, increased long term interest rates and a wider gap between the OCR and bank funding costs, reduces the need for more immediate action."

My view Reserve Bank Governor Alan Bollard has given himself some wiggle room to increase the Official Cash Rate earlier than his previous indications. That is a good thing because it's likely he'll need it. Bollard has reassured home owners this year that he would not increase the OCR from its record low of 2.5% until the second half of 2010. Not surprisingly, home buyers have taken the invitation to go out and buy houses with "˜cheap' interest rates near 6%. This, inevitably, has sparked another surge in housing market activity to the point now the Reserve Bank is forecasting annual house price inflation of 12% by the March quarter of this year. Yet Bollard is saying that this time it is different. The surge in house prices will not lead to a surge in consumer spending because, he says, home owners are being more careful this time and appear to keep their repayments up and in some cases trading down to reduce debt. Bollard is also saying he doesn't need to raise the OCR yet because he is getting help from higher long term market interest rates, a higher New Zealand dollar and the prospect of a tightening of government spending. He is essentially saying that he can keep the OCR at a record low of 2.5% despite house prices rising 12% because someone else will do the work for him of controlling inflation. That's a heroic set of assumptions. Let's hope he is right. If not, we face slipping deeper into an unsustainable cycle of consumer spending fed by foreign debt that eventually forces us to pay higher interest rates and accept lower economic growth for longer. Let's face it. Alan Bollard is a dove and just can't stand raising interest rates. He has given himself wiggle room today, but really needed to signal rate hikes in early 2010 to be sure that inflation doesn't spark up again. The most ominous line in the monetary policy statement is that non-tradeable inflation (the stuff generated domestically by businesses) is rising again back to its long term average of 3%. Alan Bollard seems relaxed about that. I'm not. Your view? We welcome your comments below