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RBNZ keeps key rate at 2.5% amid signs of stabilisation

Reserve Bank of New Zealand Governor Alan Bollard held the official cash rate at 2.5%, pointing to signs of stabilisation in global economic activity and resilience in the domestic economy.

"For the first time in some months we can also identify some clear upside opportunities for activity," Bollard said in Wellington today. Signs of a rebound in household spending and residential investment, a pick-up in net immigration, lower taxes and lower interest rates boost confidence New Zealand's recession is past its trough, he said. Still, the strong kiwi dollar adds an "unhelpful tension" to the central bank's projection and there is room for banks to reduce shorter-term lending rates, he said.

Bollard reiterated his expectation that the OCR would remain low until late 2010, and said it could move "modestly lower" in the coming quarter. The global response to the credit crisis and substantial easing in monetary and fiscal policy had improved financial conditions, but the world wasn't out of the woods yet, with New Zealand likely to experience negative or weak growth for the next few quarters, he said.

The New Zealand dollar traded at 62.88 U.S. cents, from 62.68 cents immediately before the release. The kiwi has soared 21% from its low in early March. The trade-weighted index jumped to 59.72 from 59.46 before the report.

Bollard embarked on the steepest series of cuts to the OCR in July and has slashed 575 basis points off the benchmark rate as he seeks to revive the nation's flagging economy, which fell into recession last year.

Asian economies, led by China and India, have started to show assigns of recovery, and domestic confidence has lifted from its trough.

Recent data from Quotable Value, the Real Estate Institute, Barfoot & Thompson and Harcourts New Zealand suggest a pick-up in the property market, as a surge in net migration combined with a fall in new building consents helped housing demand outstrip supply.

Electronic card spending at New Zealand retailers rose last month, according to government figures this week, suggesting lower interest rates and tax cuts have filtered through to consumer spending. Retail transactions on credit and debit cards rose 0.9% in May, the second consecutive monthly increase, according to Statistics New Zealand.

"The not-so-bad economic indicators, especially in the local housing market, have been boosting the case for an OCR pause," said Bank of New Zealand senior economist Craig Ebert, before the announcement. "Pausing but signalling further easing could arguably be the more powerful suppressor on yields for the RBNZ."

Bollard reiterated his concerns over the lack of movement by banks in passing on cuts to the OCR, and said the increase in funding costs from higher retail deposits didn't "fully explain the relative lack of movement of interest rates at shorter terms."

Earlier this week, Parliament's Finance & Expenditure select committee slammed banks for failing to pass on cuts to the OCR, accusing them of profiteering while they received tax-payer subsidies.

Banks have continued to lift long-term lending rates amid signs the first recession in a decade has begun to abate, despite the Bollard calling them "out of line" with expectations in April. Westpac Banking Corp. raised its three- and five year rates to 6.95% and 7.9% respectively, while ASB Bank became the first bank to lift its five-year rate to 8% earlier this week.

Bank of New Zealand and Australia New Zealand Bank are offering five-year rates at 7.99%, while Kiwibank, National Bank and TSB have increased their rates to 7.95%.

The banks defended the increases, saying they have had to lift the cost of lending as they raise returns on term deposits in a bid to attract offshore funding. Long-term mortgage rates have increased around 150 basis points since early February as increased government debt issuance has raised concerns about inflation when monetary policy begins to tighten.

Bollard warned the mix of a rapid rebound in consumer spending with a stronger New Zealand dollar would put the sustainability of future growth at risk, and if the currency's strength lasted too long, it could stifle the forecast recovery in the export sector.

The central bank lifted its projected average for the currency on a trade-weighted basis to 55.9 from 52.6 in its last monetary policy statement in March. It predicts the currency will keep its current strength in the coming months, before it resumes a steady depreciation into 2011.

The economy shrank 0.9% in the first three months of this year, and the central bank predicts it will contract in the second and third quarters this year. The government announced it would run operating deficits for at least the next decade.

The central bank's outlook for the current account deficit improved from its previous statement as very weak demand for imports helped rebalance the economy. It predicts the deficit will rise to 8.2% of GDP this year, before it shrinks to 6.1% in 2010. In its last forecast it predicted the deficit would rise to 8.4% this year, and remain high at 8.3% next year.

Bollard said demand for workers is now significantly weaker as skilled labour shortages have abated to comparable levels in the in the early 1990s. Unemployment rose to a six-year high 5%, and the Treasury predicts it will rise to 7.5% in the next two years. The RBNZ lifted its projection for the jobless rate to peak next year at 7.1%, up from 6.8% in the previous MPS.



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