RB leaves cash rate unchanged

As expected, Reserve Bank governor Don Brash left the official cash rate (OCR) unchanged at 5.75%, acknowledging both the strength of the domestic economy and the worsening outlook for the global economy.

Brash says underlying inflation remains well within his zero to 3% target range and that the headline inflation rate, the consumer price index (CPI), should also move back towards the middle of that range by the middle of next year. The CPI rose 3.2% in the year ended June.

Nevertheless, that are risks to that "relatively benign" assessment, Brash says.

"Inflation could turn out to be more persistent than currently seems likely. There are an increasing number of indicators suggesting that the economy may be operating slightly above full capacity," he says.

If the CPI stays close to 4% there’s a risk inflation expectations may go up, "leading to adverse consequences for wage- and price-setting," he says.

Brash says businesses are confident about the outlook for their own activity, rural sector incomes are at their highest level in many years, employment intentions are at near-record levels, and there are strong signs of a pick-up in both confidence and activity in residential construction. That was previously one of the most sluggish parts of the economy, he says.

Given those factors, "we have no reason to date to regret the relatively cautious manner in which we have reduced the OCR in recent months."

If it weren’t for the risk that the international environment will turn out to be even weaker than assumed, "the current situation would point to an early increase in the OCR," Brash says.

"The flow of economic indicators from the United States, Japan, non-Japan Asia and Europe makes a deeper and more prolonged slowdown seem quite likely,’’ he says.

If that happens "there seems little doubt that the dis-inflationary pressures on New Zealand coming from overseas would intensify. As a result, inflation could fall into the bottom half of our target range and this would necessitate further easing of monetary policy."

Brash’s rhetoric surprised no one. The key 90-day bank bills, from which floating mortgage rates are set rose from 5.82% late yesterday to 5.83%.

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