As predicted the Reserve Bank held the interest-driving official cash rate at 2.5% yesterday, but Reserve Bank Governor Alan Bollard's more bullish comments on a recovering economy could prompt an interest rate rise sooner rather than later.
The official cash rate (OCR) was dropped 50 basis points to 2.5% in March, following the Christchurch quake.
Dr Bollard appears to have softened his predictions of the effects of the quake on the economy, against strong commodity prices which could underpin inflationary pressure and cause a rise in the OCR.
"The pace and timing of increases will be guided by the speed of recovery, but for now the OCR remains on hold," Dr Bollard said yesterday.
Dr Bollard noted the recent strength of New Zealand dollar against the US - it moved up 0.09c to US82.38c after his statement yesterday - was negatively affecting other areas in the tradeable sector and constrained rebalancing of New Zealand's economy.
He said that while economic activity was significantly disrupted by the Christchurch earthquake, and many firms and households, particularly within Canterbury, continued to be adversely affected, it appeared the negative confidence effect of the earthquake on economic activity throughout the rest of the country had been limited.
"Despite some continuing signs of weakness in the world economy, commodity prices remain very strong and firms expect to increase their hiring and capital investment," he said.
Westpac economist Dominick Stephens said the Reserve Bank had "significantly altered its stance on future monetary policy" as yesterday's monetary policy statement was firmly focused on the forthcoming "surge in economic activity""Combined with strong export commodity prices, that would together put upward pressure on inflation," Mr Stephens said.
The statements stood in "marked contrast" to those in March and April, which tended to focus more on the potential negative risks stemming from earthquake-related disruption, he said.
Dr Bollard said as gross domestic product growth picked up, underlying inflation was expected to rise. A gradual increase in the OCR during the next two years will be required to offset this, such that consumer price index inflation tracked close to the midpoint, 2%, of the target band during the latter part of the projection.
ASB economist Nick Tuffley said the Reserve Bank was now more confident that the country's recovery was picking up and that the wider economy has held up in the wake of the earthquake.
"The Reserve Bank has become more comfortable that the wider economy is starting to pick up, but less comfortable about the inflation outlook," Mr Tuffley said.
Both of these factors raised the risk of an earlier tightening of the OCR than we have previously thought and the ASB had shifted its forecast of the OCR being tightened in March next year, to January.
Economist for the Council of Trade Unions, Bill Rosenberg, was pleased the Reserve Bank held the OCR yesterday, saying its 50 basis point OCR reduction after the February earthquake was likely to have contributed to the economy not being hit as hard as it could have been.
However, given the Government had removed its fiscal stimulus in its 2011 Budget, monetary stimulus is all that remains and there was no case for the Reserve Bank to raise the OCR before next year.
Noting wage growth projections were "modest" and the labour cost index was expected to peak at 2.4% in March, Mr Rosenberg said "wage and salary earners are overdue for real increases in their incomes".
Federated Farmers welcomed the hold, but cautioned an upbeat economy and higher interest rates also spelt out higher borrowing costs, amid the bigger threat of on-farm inflation.
Federated Farmers economic and commerce spokesperson.
Philip York said well before the Reserve Bank began a tightening of monetary policy, farmers may see an increase in the cost of borrowing, in response to new Reserve Bank's capital adequacy ratios for farm lending.
"Given farmers will prioritise debt reduction in order to bank an increasingly bright commodities picture, we restate our firm belief commodity income will not be a threat to inflation," Mr York said in a statement.
