The Reserve Bank left the official cash rate (OCR) unchanged at 2.5 percent today, but Governor Alan Bollard made it clear he sees room for more cuts to shorter term lending rates.
Dr Bollard also warned of the risk posed by the current strength of the New Zealand dollar.
"A stronger dollar at a time of weak global growth risks delaying or even reversing the projected increase in exports, putting the sustainability of recovery at risk," he said when announcing the OCR decision today.
The OCR was at 8.25 percent throughout the year to last July before being brought down quickly as the global financial crisis hit the economy, with the last cut being a 50-basis point drop at the end of April.
Dr Bollard said he expected the effects of the large OCR cuts to pass through to more borrowers over coming quarters as existing fixed-rate mortgages come up for re-pricing.
"Although rising longer term interest rates overseas are placing upward pressure on longer term lending rates here, there is room for further reductions in shorter term lending rates," he said.
In its Monetary Policy Statement published today, the Reserve Bank did acknowledge that the cuts to the OCR during the past year had passed through more than in most countries to the interest rates faced by households and businesses.
"However, it appears as though the most recent reductions in the OCR have not been passed on to borrowers to the extent that we would have expected," the statement said.
"While there has been some increase in funding costs from higher retail deposit rates and longer term interest rates offshore, this does not appear to fully explain the relative lack of movement of interest rates at shorter terms." The bank also raised doubts about the sustainability of the upturn in the housing market during the past few months.
According to industry contacts, it seemed that with housing turnover so low through 2008, a backlog of house buyers developed, the statement said.
With mortgage rates now at historical lows, and many buyers believing price declines would be more limited in the future, house sales had increased. A surge in net permanent and long term immigration could also be a factor.
"Nonetheless, while improved housing market turnover may well continue for the next couple of months, we expect the pick-up ultimately to be short lived, and dominated by the risk of unemployment and high debt levels facing households," the statement said.
At the same time it said that while the recent consolidation was not expected to flow through to a quick or large rebound in house prices, residential investment was expected to recover in 2010.
On the wider economy, activity in this country and many of its trading partner economies looked to have undershot the already very weak projections made by the Reserve Bank in March, the statement said.
But for the first time in some months, the Reserve Bank had increased confidence that activity here and abroad would trough during the next quarter or two.
The prolonged period of weak global activity and the recent appreciation in the NZ dollar were projected to continue to weigh on demand for New Zealand exports for some time yet, the bank said.
But the situation was expected to begin to turn around early next year, with both export volumes and prices recovering on the back of a resumption in world growth and an assumed depreciation in the NZ dollar.
The decline in the annual average gross domestic product was expected to trough at 2.4 percent later this year, before recovering to growth of just below 4 percent in late 2011. That was both a deeper trough and slower recovery than during the recession of the early 1990s.
But the statement warned a sustained period of NZ dollar strength could stifle the projected recovery in exports and hence overall activity.
"The combination of a stronger NZ dollar, and hence weaker export growth, and a rapid rebound in household spending would represent an unfortunate mix of macroeconomic conditions going forward," the statement said.
Such a picture was not the most likely outcome for now, but if it happened it would likely imply current macroeconomic imbalances, particularly aggregate household indebtedness and the current account deficit, remaining high or even rising.
That could put the sustainability of the next expansion at risk, as the vulnerability of the economy to a change in foreign investor sentiment would remain high or could worsen.
