Photographer: Mark Coote/Bloomberg

RBNZ Keeps Key Rate at Record Low on Weak Inflation Outlook

  • Central bank doesn’t expect to raise rates for two years
  • Wheeler says lower New Zealand dollar needed; currency rises

New Zealand’s central bank held interest rates at a record low and said it doesn’t expect to raise them for two years amid weak inflation.

“Monetary policy will remain accommodative for a considerable period,” Reserve Bank Governor Graeme Wheeler said in a statement after keeping the official cash rate at 1.75 percent. The bank maintained its forecast that rates won’t rise until the third quarter of 2019, and lowered its projections for inflation.

The RBNZ’s surprisingly cautious tone in recent months has been justified by the latest data. Inflation has slowed more than economists forecast and economic growth has disappointed on the downside. The strong New Zealand dollar remains a headache for the bank, damping import prices and suppressing inflation.

“A lower New Zealand dollar is needed to increase tradables inflation and help deliver more balanced growth,” Wheeler said.

The currency nevertheless rose after the statement to trade at 73.51 U.S. cents at 12:27 p.m. in Wellington. The kiwi has climbed more than 7 percent against the greenback since the RBNZ’s last set of forecasts on May 11.

“While the basic tone of the Monetary Policy Statement was as expected, we were a little surprised that the RBNZ’s reaction to recent weaker data was so muted,” said Dominick Stephens, chief economist for New Zealand at Westpac Banking Corp. in Auckland. “Markets were primed for something slightly more dovish.”

Weaker Inflation

All 11 economists surveyed by Bloomberg expected today’s decision, and most forecast the benchmark rate will remain at 1.75 percent for another year. Swaps data show about an 80 percent chance of an increase by next August.

ASB Bank economists said the mild surprise in today’s release was that the central bank didn’t push out its forecast policy tightening due to a weaker inflation outlook. 

“Nevertheless, we still expect the RBNZ will end up lifting the OCR slightly earlier than its forecasts imply” as it is underestimating the stimulatory impact of the recovering dairy sector and the price pressures generated by record immigration, they said in a research note.

Inflation accelerated to 2.2 percent in the March quarter, returning to its 2 percent goal for the first time in more than five years. But that was due to temporary influences such as food and fuel prices. It slowed to 1.7 percent in the June quarter, and the RBNZ today predicted the rate will drop to 0.7 percent in the first quarter of 2018 -- lower than it previously expected.

Economic Growth

“Headline inflation is likely to decline in coming quarters as the effects of higher fuel and food prices dissipate,” Wheeler said. Still, inflation will return to the midpoint of the target range “over the medium term.”

Wheeler said growth is “expected to improve going forward,” supported by low borrowing costs, strong population growth, an elevated terms of trade and fiscal stimulus. Growth will accelerate to 3.8 percent in the year to March from 2.5 percent in March this year, the RBNZ predicted.

While New Zealand’s economy has been expanding at a healthy clip the past several years, supported by immigration and booming tourism and construction, growth fell short of expectations in the fourth quarter of 2016 and the first quarter of 2017. Employment unexpectedly declined in the second quarter as firms became more cautious, and wage inflation remains subdued.

Housing Market

New Zealand’s housing market is also cooling, led by a drop in Auckland prices, which may reduce pressure on inflation and keep interest rates lower for longer. Annual house-price growth slowed to 2.8 percent in June from 5 percent in May and 10 percent in March, the Real Estate Institute of New Zealand said last month.

That’s at least partly due to lending restrictions introduced by Wheeler, whose five-year term as governor ends Sept. 26.

“House-price inflation continues to moderate due to loan-to-value ratio restrictions, affordability constraints, and a tightening in credit conditions,” Wheeler said. “This moderation is expected to persist, although there remains a risk of resurgence in prices given continued strong population growth and resource constraints in the construction sector.”

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