Reserve Bank still 'sitting on fence'

The Reserve Bank yesterday kept its official cash rate at 2.5%, caught between two opposing forces, Westpac chief economist Dominick Stephens said.

Local growth had picked up considerably, driven by the post-earthquake Canterbury rebuilding and rising house prices.

However, inflation was below the Reserve Bank's target and could go lower from here, due to the inflation-suppressing effects of the high New Zealand dollar, he said.

''The Reserve Bank can't hike the OCR early for fear of exacerbating the high exchange rate and pushing inflation even further below target in the short run.

''Equally, it can't reduce the OCR, or keep it unchanged forever, for fear of stoking the overvalued housing market and creating runaway inflation in the longer-term.

''So the Reserve Bank has sensibly opted to continue sitting on the fence,'' Mr Stephens said.

At some point, one or the other of the opposing forces would win, forcing the Reserve Bank to climb down from its current position, he said.

Westpac's money was on rebuild and housing-induced domestic inflation eventually proving the more pertinent long-run influence.

Over the course of New Zealand's history, construction booms had generated inflation pressures and rising house prices had provoked consumer spending, he said.

''We believe those same patterns will be repeated in the upcoming cycle and we don't believe the Reserve Bank has taken sufficient account of that.''

The evolution from construction boom and rising house prices to widespread inflation pressures would be slow, Mr Stephens said.

The Reserve Bank had time on its side and Westpac now expected the OCR would remain on hold at 2.5% until March next year.

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