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Reserve Bank raises OCR to 3 percent

New Zealand’s economic expansion has considerable momentum, with GDP estimated to have grown by 3.5 percent in the year to March. Growth is gradually increasing in New Zealand’s trading partners, but inflation in those economies remains low. Global financial conditions continue to be very accommodating.

Prices for New Zealand’s export commodities remain very high, though auction prices for dairy products have fallen by 20 percent in recent months. Domestically, the extended period of low interest rates and strong growth in construction sector activity are supporting the recovery. Net immigration continues to increase, boosting housing and consumer demand. Confidence remains very high among households and businesses, and measures of investment and employment intentions are positive.

Spare capacity is being absorbed, and inflationary pressures are becoming apparent, especially in construction and other non-tradable sectors. The high exchange rate remains a headwind to the tradables sector, and along with low import price inflation has been holding down tradables inflation. The Bank does not believe the current level of the exchange rate is sustainable.

There has been some moderation in the housing market. Restrictions on high loan-to-value ratio mortgage lending are easing pressure, and rising interest rates will have a further moderating influence. However, the increase in net immigration is adding to housing demand.

Headline inflation is moderate, but inflationary pressures are increasing and are expected to continue doing so over the next two years. In this environment it is important that inflation expectations remain contained. To achieve this it is necessary to raise interest rates towards a level at which they are no longer adding to demand. The speed and extent to which the OCR will be raised will depend on economic data and our continuing assessment of emerging inflationary pressures, including the extent to which the high exchange rate leads to lower inflationary pressure.

By increasing the OCR as needed to keep future average inflation near the 2 percent target mid-point, the Bank is seeking to ensure that the economic expansion can be sustained.

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