The Reserve Bank today reduced the Official Cash Rate (OCR) by 25 basis points to 3.25%.
Growth in the global economy remains moderate. Data on economic activity in the US, China and Australia has been mixed, although there has been some improvement in the euro area and Japan. Volatility in financial markets has increased.
The New Zealand economy is growing at an annual rate around three percent, supported by low interest rates, high net migration and construction activity, and the decline in fuel prices. However, the fall in export commodity prices that began in mid-2014 is proving more pronounced. The weaker prospects for dairy prices and the recent rises in petrol prices will slow income and demand growth and increase the risk that the return of inflation to the mid-point would be delayed.
Inflation has been low due to falling import prices and the strong growth in the economy’s supply potential. Wage inflation and inflation expectations have been subdued.
With the fall in commodity prices and the expected weakening in demand, the exchange rate has declined from its recent peak in April, but remains overvalued. A further significant downward adjustment is justified. In light of the forecast deterioration in the current account balance, such an exchange rate adjustment is needed to put New Zealand’s net external position on a more sustainable path.
House prices in Auckland continue to increase rapidly, and increased supply is needed to address this. The proposed LVR measures and the Government’s tax initiatives planned for 1 October 2015 should ease the impact of investor activity.
A reduction in the OCR is appropriate given low inflationary pressures and the expected weakening in demand, and to ensure that medium term inflation converges towards the middle of the target range.
We expect further easing may be appropriate. This will depend on the emerging data.
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