March 14 (Bloomberg) -- New Zealand’s central bank expects to keep borrowing costs at a record low until next year and signaled it may reduce its benchmark rate if the local dollar rises more than the economy justifies. The kiwi fell.
“The overvalued New Zealand dollar is undermining profitability in export and import competing industries, and worsening drought conditions are creating difficulty in much of the country,” Reserve Bank Governor Graeme Wheeler said in a statement released today in Wellington after keeping the benchmark rate at 2.5 percent. “We expect to keep the official cash rate unchanged through the end of the year.”
New Zealand’s dollar dropped to the lowest level this year after Wheeler said he’s set to extend the RBNZ’s two-year pause amid an “uneven” economic recovery. Unexpected strength in the currency -- which has climbed 11 percent in the past two years - - could provide room to lower borrowing costs, he said.
The statement “was more dovish than the market expected,” Westpac Banking Corp.’s Auckland-based strategist Imre Speizer said in a research report after the decision. “Indeed it included an alternative scenario where easing could occur if the NZD appreciates above its forecast.”
New Zealand’s dollar declined as much as 1.3 percent to trade at the lowest since Dec. 26. It bought 81.89 U.S. cents at 11:02 a.m. in Wellington compared with 82.68 cents immediately before the statement. The yield on the two-year government bond dropped to 2.59 percent, from 2.64 percent.
“If the exchange rate rose for reasons not justified by New Zealand’s economic fundamentals, all other things equal, this would lead to a lower-than-expected OCR,” the RBNZ said in its quarterly monetary policy statement also published today.
The rate decision was forecast by all 16 economists in a Bloomberg News survey. Seven had been predicting a rate rise this year, while nine saw no change until 2014.
Wheeler indicated confidence the economy will rebound, led by stronger global growth, a lift in residential investment and reconstruction of earthquake devastated Christchurch. The eventual boost to demand may drive up labor costs and other prices, which have been contained by the stronger kiwi.
Still, the labor market remains weak and fiscal tightening will also act to slow overall demand, Wheeler said today.
The central bank forecast the three-month bank bill yield will be 2.8 percent in the second quarter next year from an estimated 2.7 percent in the current quarter. The outlook, which is seen as a guide to the direction of the cash rate, suggest no increase in the benchmark until mid 2014.
Dry conditions are weighing on farm production and if they persist or intensify “they could substantially reduce economic output more generally,” the central bank said in the statement.
New Zealand has declared drought in several North Island regions including Waikato and Taranaki, the largest dairying provinces. Fonterra Cooperative Group Ltd., the world’s biggest dairy exporter, last month revised lower its forecast for milk collection citing the dry conditions.
The drought may pare back economic growth, Finance Minister Bill English said in response to questions in parliament this week. Economists at Bank of New Zealand Ltd. lowered their projections for first-half economic growth to 1.1 percent from 1.3 percent because of the drought.
The central bank left its economic growth projections little changed. It predicts gross domestic product will increase 1.9 percent in the year ending March 31, 2013. Growth will accelerate to 3.3 percent by March 2014 then slow to 2.8 percent a year later, it said.
New Zealand suffered its deadliest earthquake in 80 years in February 2011 when a temblor struck the city of Christchurch, killing 185 people and wrecking roads, homes and commercial property. The nation faces an estimated NZ$30 billion ($24.5 billion) rebuild.
“The Canterbury rebuild is gaining momentum,” Wheeler said today. “Residential investment and business and consumer confidence are increasing.”
Wheeler reiterated his Jan. 31 message that he is watching house prices closely.
“The bank does not want to see financial stability or inflation risks accentuated by housing demand getting too far ahead of supply,” he said.
House prices rose 6.3 percent in February from a year earlier, Quotable Value New Zealand, a government-owned property research company, said this week. The central bank expects annual house price inflation will peak at 8.5 percent in 2014.
Wheeler this month sought submissions on new tools he may apply to counter a housing-led credit boom that may threaten bank stability. They include increasing minimum deposits for borrowers and requiring lenders to raise more capital. The tools would have the effect of damping demand for houses, he says.
Recent increases in housing demand have been supported in part by an easing in credit conditions, the central bank said today. Mortgages with a high loan-to-value ratio have been increasing and household credit growth is picking up, it said.
The central bank has left the cash rate unchanged since March 2011 to allow the economy to recover from the earthquakes, and to revive confidence after Europe’s sovereign debt crisis curbed global demand. Exporters were also buffeted by near-zero interest rates in the U.S. and Europe which helped boost the New Zealand dollar.
Sluggish growth and the rising currency slowed inflation to 0.9 percent in the fourth quarter from a year earlier, beneath the central bank’s 1 percent to 3 percent target range.
Wheeler, who took over from Alan Bollard in late September, signed an agreement with English in which he undertook to keep inflation near the 2 percent midpoint of the target range.
Inflation will accelerate to 1.3 percent by the end of 2013 and 1.7 percent a year later, the RBNZ forecast today. It isn’t projected to reach 2 percent until the third quarter of 2015.
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