New Zealand Leaves Key Rate Unchanged at Record High

Sep 13, 2007 - New Zealand's central bank left the benchmark interest rate at a record-high 8.25 percent, saying a declining currency and higher prices for commodity exports will stoke the economy and fan inflation.

"We continue to expect a significant boost to the economy over the next two years from the sharp rise in world prices for dairy products and some other commodities," Reserve Bank Governor Alan Bollard said in a statement released in Wellington today. Still, global financial market volatility increases the likelihood of a weaker economic outlook for the nation's trading partners such as the U.S., he said.

Bollard has little scope to cut borrowing costs because wages are rising and a 3.5 percent decline in the New Zealand dollar the past month has swelled earnings for exporters. The central bank will wait to see if consumer spending and housing demand slow before contemplating a rate cut, said economist Stephen Toplis.

"If you take the central bank at face value, they're not talking about a cut in rates until the second half of 2009," said Toplis, head of research at Bank of new Zealand Ltd. in Wellington. The currency rose to 71.24 U.S. cents at 10 a.m. in Wellington from 71.18 cents immediately before the statement. It has fallen from a 22-year high of 81.10 cents on July 24.

All 14 economists surveyed by Bloomberg News predicted today's decision. Just four expect a rate cut before June 30 next year.

Inflation Forecast

"Inflation is likely to rise due to the effects of a low exchange rate and higher food prices," Bollard said. "It is important that this temporary increase doesn't affect prices or wage-setting behavior."

Bollard is required by the government to keep inflation between 1 percent and 3 percent. Annual inflation will accelerate to 2.9 percent by March next year and 3 percent by March 2009, the central bank said today. Consumer prices rose 2 percent in the year ended June 30.

"The current level of the official cash rate is consistent with the future inflation outcomes of 1 percent to 3 percent," Bollard said.

The New Zealand dollar's decline against the U.S. currency has increased earnings from the nation's biggest exports, such as milk powder, cheese and yoghurt. Auckland-based Fonterra Cooperative Group Ltd. is the world's biggest exporter of dairy products.

"A sharp decline in the New Zealand dollar since July, if sustained, will act to reinforce the effects of higher world prices" for the nation's commodities, Bollard said.

Jobless Rate

New Zealand's jobless rate fell to a record 3.6 percent in the second quarter as companies added more than twice the number of workers forecast by economists. A skills shortage sparked a record 3.2 percent wage increase for non government workers in the second quarter from a year earlier.

Central banks around the world have kept borrowing costs unchanged as they assess whether the U.S. subprime mortgage rout will derail global economic growth.

The Reserve Bank of Australia last week kept its benchmark rate at 6.5 percent. The European Central Bank left its rate at 4 percent and lowered its forecast for growth in Europe. The U.S. Federal Reserve will probably cut its main rate next week, according to a majority of 117 economists surveyed by Bloomberg News.

"Credit concerns and heightened risk aversion have led to significant turbulence in global financial markets," Bollard said. "The consequences of this turmoil for New Zealand remain unclear at this stage."

Domestic Spending

Bollard raised rates four times between March and July to curb domestic demand and inflation. Recent indicators "suggest that previous rate increases are starting to dampen domestic spending," he said.

House sales fell to an 18-month low in July, according to a Real Estate Institute report released on Aug. 9. Home-building approvals fell to a three-month low in July, the government said last week.

Retail sales unexpectedly declined in June. Sales excluding inflation, a measure of volumes, also fell in the three months ended June 30, the first drop in six quarters.

Consumer confidence slipped to a 15-month low last week, according to a poll of 1,000 voters conducted for TV3 Network Ltd.

"The trading environment was much tighter than for the first half of last year," Rod Duke, chief executive officer of retailer Briscoe Group Ltd., said on Sept. 7. "Low levels of consumer confidence in the economic outlook contributed to tightening trading conditions."

The Auckland-based home ware and sporting goods retailer said first-half profit fell 12 percent.

Economic Growth

Economic growth will accelerate to 2.9 percent in the year ending March 31, 2008, from 1.7 percent a year earlier, the central bank said today. In June, the bank forecast 3.1 percent growth this year.

The central bank expects housing investment will contract in the year to March 2009. Consumer spending and demand for imports will remain strong and growth will be buoyed by rising exports.

Higher global prices for its dairy products prompted Fonterra to raise its 2008 milk payment forecast to a record. That will add NZ$2.6 billion ($1.8 billion) to New Zealand farmers' incomes.

New Zealand's official cash rate, introduced in March 1999, is 7.75 percentage points more than Japan's benchmark.

The currency has gained 10 percent the past year as traders borrow at cheaper rates in Japan and invest in New Zealand's higher yields, in what is known as the carry trade.

Still, the currency dropped the past month as growing concern that defaults on U.S. home loans to people with poor credit histories prompted fund managers to avoid risky investments such as the carry trade.