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Slight interest rate rise forecast

The Reserve Bank holds rates, worries about house prices and the exchange rate and still considers its new tools.

The Reserve Bank has made little change to its interest rate forecasts in its monetary policy statement today, but still remains worried about house prices and the exchange rate.

It has left the official cash rate at 2.5% and repeated its previous position that it expects “to keep the OCR unchanged through the end of the year".

Its 90-day interest rate forecast shows rates will be slightly higher from the middle of 2015 than forecast in the March statement.

“This reflects the inflationary effects of the stronger outlook for domestic demand, offset somewhat by a stronger exchange rate forecast.”

While it is worried that house price inflation, particularly in Auckland and Christchurch, gets ahead of the supply response and cause financial or price stability.

Despite this there is no mention in the OCR statement about the bank using its new macro-prudential tools to try and contain the housing market.

This can be explained by the fact that the bank has a framework for its new tools, but it is still consulting on the possible implementation of them.

In its monetary policy statement the bank says that its central projection is that house price inflation will moderate soon.

“House price inflation is projected to rise modestly over the coming half year, before tracking lower thereafter. This projection assumes unchanged prudential policy settings.”

Nationally house prices rose 9% over the year to April. Prices were up 14% and 11% in Auckland and Christchurch respectively and outside these areas rose by around 4%.

The bank says house prices are very high relative to rents and household income.

While the bank’s central projection illustrates its discomfort, it says a key risk is that house price inflation is stronger than forecast and the bubble may burst.

“The bank is concerned that the current escalation in house prices is increasing the probability and potential harm of a significant downward correction in house prices.”

This concern comes from a view that prices can’t keep rising at current rates and debt levels will become unserviceable.

The three main factors behind today’s decision to leave the OCR unchanged are;
- The global outlook remains mixed with disappointing data in Europe and other countries and positive indicators in the United States and Japan.
- Economic growth is picking up, but is uneven across the sectors. Two of the key drivers of growth are the Canterbury rebuild and construction activity in Auckland.
- The dollar remains over-valued, despite falling in recent weeks, and remains a headwind for the tradable sector. It is restricting exports and encouraging demand for imported goods.

Reserve Bank governor Graeme Wheeler forecasts that that annual GDP growth will accelerate to about 3.5% by the second half of 2014 and inflation will rise to towards the midpoint of the 1-3% target band.



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