OCR rises to 3.5%

Graeme Wheeler
Graeme Wheeler
The Reserve Bank has lifted the benchmark Official Cash Rate by 25 basis points to 3.5 per cent.

With this fourth successive increase in the official cash rate widely expected, the focus is now what the brief accompanying statement indicates on the Reserve Bank's thinking about the duration and conditionality around the likely pause to follow.

The 16 forecasters polled by Reuters put a 75 per cent probability on the bank raising the OCR 25 basis points to 3.5 per cent this week, but six of them expect that to be it until next year, and the other 10 don't see the bank raising rates again until December.

A fourth OCR lift today means the bank has delivered half of the tightening it projected in June would be necessary over two years. 

New Zealand's economy is expected to grow at an annual pace of 3.7 per cent over 2014.

Global financial conditions remain very accommodative and are reflected in low interest rates, narrow risk spreads, and low financial market volatility. Economic growth among New Zealand's trading partners has eased slightly in the first half of 2014, but this appears to be due to temporary factors.

Construction, particularly in Canterbury, is growing strongly. At the same time, strong net immigration is adding to housing and household demand, although house price inflation has moderated further since the June Statement.

Over recent months, export prices for dairy and timber have fallen, and these will reduce primary sector incomes over the coming year. With the exchange rate yet to adjust to weakening commodity prices, the level of the New Zealand dollar is unjustified and unsustainable and there is potential for a significant fall.

Inflation remains moderate, but strong growth in output has been absorbing spare capacity. This is expected to add to non-tradables inflation. Wage inflation is subdued, reflecting recent low inflation outcomes, increased labour force participation, and strong net immigration.

It is important that inflation expectations remain contained. Today's move will help keep future average inflation near the 2 per cent target mid-point and ensure that the economic expansion can be sustained. Encouragingly, the economy appears to be adjusting to the monetary policy tightening that has taken place since the start of the year. It is prudent that there now be a period of assessment before interest rates adjust further towards a more-neutral level.

The speed and extent to which the OCR will need to rise will depend on the assessment of the impact of the tightening in monetary policy to date, and the implications of future economic and financial data for inflationary pressures."

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