Policy assessment
The Bank has decided to leave the Official Cash Rate at 4.5 percent. This decision is based on our current assessment of the likely degree of inflation pressure over the next one to two years, which is substantially unchanged from that outlined in the March Statement.
Our projections continue to suggest economic activity growing at around 0.7 to 0.8 percent per quarter - or about three percent per annum - with a mild pick-up in momentum towards the end of this year and beyond. The projected growth is still largely domestically-led, although a brighter outlook for export activity is also anticipated. The Consensus outlook for growth in our major trading partners has changed little since March, but global financial markets have stabilised and there appears less risk of further financial turmoil in the near future.
We estimate that the moderate growth rates which we project will absorb the current spare capacity over the next two years or so. However, as long as material spare capacity continues to exist in the economy, it will place downward pressure on general inflation. As a result, the Bank will continue to stimulate the economy with fairly easy monetary conditions.
Against the background of generally low inflation, we expect a number of one-off price increases to result in higher CPIX inflation in the second half of this year. It is our assessment that these price shifts are unlikely to precipitate generalised inflation pressures. Consequently, we do not regard it as appropriate for monetary conditions to respond. Monetary policy instead remains focused on the medium-term trends in general inflation pressure.
Since the initial setting of the Official Cash Rate on 17 March, the New Zealand dollar has appreciated by around 6 percent, leading to a firming in monetary conditions. This latter development, all other things equal, would suggest reducing the Official Cash Rate. Obviously, if the recent firming of conditions proves to be persistent, and not well-justified by the emerging data, the Bank may have to look at reducing the Official Cash Rate in the future.
Right now, though, caution appears warranted. The factors driving the recent rise in the currency are unclear. If the appreciation proves temporary, or if, perhaps, it reflects an expectation in the market of stronger trading-partner growth that is subsequently justified, a reduction in the Official Cash Rate now might soon have to be reversed. On balance, it thus appears prudent to wait, leaving the OCR unchanged, and to continue to monitor relevant information as it comes to hand.
The key risks surrounding our inflation outlook remain a stronger-than-expected rebound in household spending, and possibly weaker-than-expected growth in New Zealand's trading partners. As always, we stand ready to adjust the stance of monetary policy as appropriate, in the light of emerging information about medium-term trends in inflation.
Donald T Brash
Governor