The Reserve Bank yesterday did its best to dampen down expectations of the more exuberant interest rate cut expectations and indicated it clearly wanted a further fall in the value of the dollar.
Governor Graeme Wheeler said in a much-anticipated speech in Tauranga further exchange rate depreciation was necessary, given the weakness in export commodity prices and the projected deterioration in the country's net external liabilities over the next two years.
In response, the dollar and trade-weighted index rose as speculators interpreted Mr Wheeler's comments as being relatively positive about the economy through his efforts to reduce expectations about future cuts in the official cash rate.
ASB chief economist Nick Tuffley remained comfortable with a view the Reserve Bank would cut the OCR by 0.25% in both September and October, to 2.5%.
Meanwhile, Westpac senior economist Michael Gordon remained comfortable calling for a low in the OCR of 2%.
''This view is not based on a forecast recession but on what will be needed to meet the Reserve Bank's inflation target over the medium term. We expect that flow of information over the next few months will persuade the Reserve Bank to lower its interest rate projections further.''
Annual inflation was just 0.3% and it had been consistently below the 2% mid-point of the Reserve Bank's target range for nearly four years, he said.
The central bank expected inflation to be close to the 2% mid-point by the first half of next year, with the recent fall in the New Zealand dollar pushing up the prices of tradeable goods.
The Reserve Bank judged that was an an appropriate pace of adjustment back to its medium-term inflation target.
However, a fall in the exchange rate would generate only a transitory burst of inflation, Mr Gordon said.
''Maintaining inflation close to 2% is likely to require sustained decline in the New Zealand or a significant pick-up in domestic activity. But neither of those will happen if the Reserve Bank cuts the OCR by only another quarter percent or so.''
In his speech, Mr Wheeler warned the exchange rate remained above the level consistent with economic conditions.
At current levels of export prices, a more substantial exchange rate depreciation would be required to stabilise the net external liabilities position relative to gross domestic product (GDP).
There was potential for further downward pressure on global dairy prices, he said.
''Also, over coming months, the Federal Reserve and the Bank of England are likely to begin the process of normalising their interest rates, which could assist our currency lower.''
Turning to interest rates, Mr Wheeler said current monetary policy settings were providing stimulus to the economy at a time when output looked to be growing about 2.5%, slightly below potential.
Some local commentators had predicted large interest rate falls
over coming months that could only be consistent with the economy moving into recession.
The bank would review its growth forecasts in the September Monetary Policy Statement.
''But, at this point, we believe several factors are supporting economic growth. These include the easing in monetary conditions, continued high levels of migration and labour force participation, ongoing growth in construction and continued strength in the services sector.''
The Reserve Bank was conscious of the impact low interest rates could have on housing demand and its potential to feed into higher house-price inflation.
Lower interest rates risked exacerbating the already extensive housing pressures in Auckland by stimulating housing demand, although outside Auckland nationwide house price inflation was running at an annual rate of about 2%.
But in the present situation, raising interest rates would be inappropriate as it would put upward pressure on the exchange rate and further dampen consumer price index inflation, Mr Wheeler said.
