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RBNZ reviewing 4.5% 'neutral' monetary policy setting

12 Mar 2015

The Reserve Bank is reviewing its 4.5 percent assumption for a neutral official cash rate setting as globally low inflation feeds into the local economy through the exchange rate.

Governor Graeme Wheeler told Parliament's finance and expenditure committee that work is underway to review what the central bank thinks is a neutral setting - where the OCR neither stimulates nor holds back economic growth. It's traditionally thought that's around 4.5 percent, but is "less sure of that," Wheeler said.

"We want to do more work around that" in terms of ensuring lower interest rates are consistent with economic growth that isn't inflationary, he said.

In today's monetary policy statement, the bank said it lowered its neutral nominal 90 day interest rate assumption following the global financial crisis, but was still unsure whether those changes were sufficient to reflect developments in recent years, including the more recent signs that longer term inflation expectations have adjusted lower.

Reserve Bank chief economist John McDermott told the committee the country's strong exchange rate was one of the channels through which low global inflation was feeding into New Zealand, and that "might be something we have to lean against."

Wheeler again reiterated his view that the local currency was unjustifiably high and unsustainable, and that "a substantial downward correction in the real exchange rate was needed to put New Zealand's external accounts on a more sustainable footing."

He welcomed the kiwi's recent decline against the greenback as global markets prepare for the US Federal Reserve to start raising interest rates, and said the central bank would prefer the Fed to act earlier rather than later.

The kiwi jumped more than 1 US cent in response to the statement, after some traders were surprised by Wheeler's view that rates could go still go up. The local currency recently traded at 73.20 cents.

The bank today kept the OCR at 3.5 percent while dropping any future increases from the forecast track of the 90-day bank bill rate, which is seen as a proxy for the key rate, with a strong currency, the slump in oil prices and low global inflation keeping the pace of local consumer price increases subdued.

The bank can look through the initial price shock of the drop in oil prices, which is seen as a one-off, but if that feeds into reduced wage and price expectations, Wheeler may have to respond with lower interest rates.

When considering today's review, Wheeler told the committee that he weighed up interest rate cuts by about 20 other central banks, including seven in advanced economies, since January, but decided New Zealand's strong economic momentum, growing labour market, falling fixed-term mortgage rates, and positive output gap - where growth isn't inflationary - meant a reduction wasn't warranted.

"The cost of capital doesn't appear to be a significant constraint for business," Wheeler said. "If you look at the monetary policy setting, it's 3.5 percent, we still say it's expansionary, stimulatory for the economy."

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