NZ dollar drops 0.6c on OCR news

The New Zealand dollar fell more than half a cent following Reserve Bank Governor Graeme Wheeler holding the interest-driving official cash rate (OCR) at its record low 2.5% yesterday; as expected.

While the Reserve Bank acknowledged there were various both negative and positive risks facing the economy, analysts have raised concerns of the effects of the worsening drought detracting from the Canterbury rebuilding work stimulus.

While the drought effects might be too immediate to have been factored into the Mr Wheeler's March monetary policy statement yesterday, he said the current dry conditions across New Zealand ''will weigh on agriculture production in the first half of the year''.

''If dry conditions persist or intensify they could substantially reduce economic output more generally,'' he said.

An official drought was declared across much of the North Island last week, estimates of lost productivity have been about $1 billion and low hydro lake levels prompted the Bluff aluminium smelter to scale back production by 5%, BusinessDesk reported.

ASB chief economist Nick Tuffley said New Zealand's economic recovery remained ''uneven'', as Mr Wheeler outlined, with demand and output expanding, but the labour market remaining weak.

''The Canterbury rebuild is gaining momentum and residential investment and business and consumer confidence are increasing,'' he said.

House price inflation was increasing and the Reserve Bank did not want to see financial stability, or inflation risks, accentuated by housing demand getting too far ahead of supply.

''The overvalued New Zealand dollar is undermining profitability in export and import competing industries, and worsening drought conditions are creating difficulty in much of the country,'' Mr Tuffley said yesterday.

Westpac chief economist Dominick Stephens said there was relatively little commentary on the recently-declared drought; unsurprising given forecasting time frames.

The Reserve Bank delivered a ''slightly more dovish'' review of the OCR review than Westpac or markets expected. The two-year bank swap rates fell 10 basis points while the kiwi fell by 0.6c, he said.

''[However] if the drought persists, we expect fuller commentary from the Reserve Bank in future statements,'' he said.

Mr Tuffley said ASB projected the economy to grow at an annual rate of between 2% and 3%, while inflation was expected to rise gradually towards the 2% midpoint of the target range.

Mr Wheeler said: ''The downside risks around global growth have receded in recent months, and financial market sentiment has improved''.

The heated housing market remains of high concern to Mr Wheeler.

''House price inflation is increasing and the [Reserve] Bank does not want to see financial stability or inflation risks accentuated by housing demand getting too far ahead of supply,'' he said in the monetary policy statement yesterday.

Council of Trade Unions economist, Bill Rosenberg, said the Reserve Bank should not let house price inflation drive the rest of the economy.

''While the Reserve Bank has clearly signalled that any increase in its official cash rate is unlikely before the end of the year, it would be wrong to raise interest rates after that time solely because of the threat of house price inflation,'' he said.

Growth in the economy was being held back by Government cuts to expenditure, and the only real areas of growth identified are the Christchurch rebuild and construction.

''If it considers that house prices are the biggest inflationary threat, it should not repeat the mistakes of the 2000s and raise interest rates simply to try to control house prices. That would kill growth in the rest of the economy,'' Mr Rosenberg said.

simon.hartley@odt.co.nz