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RBNZ surprised by lack of effect from low interest rates

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Fuseworks Media
Fuseworks Media

Wellington, Dec 9 NZPA - The Reserve Bank has been surprised at the limited impact low interest rates have had on the economy.

Announcing today that it was keeping the official cash rate (OCR) at 3 percent, the Reserve Bank said aggregate activity was weaker than expected in the June quarter and forward indicators of growth had softened in recent months.

That weakness partly reflected the continued cautious borrowing and spending behaviour of households and firms, the Reserve Bank said in its latest Monetary Policy Statement (MPS).

ASB bank chief economist Nick Tuffley said the big change in the statement was in how the Reserve Bank was viewing the effectiveness of interest rates on activity.

It had been surprised during the past three months at the lack of traction from current low rates.

"The legacy of the global financial crisis is that economies around the world, including NZ's, are undergoing big shifts," Mr Tuffley said.

Some of those were usual, but amplified cyclical movements, while others were more permanent structural shifts.

"Telling the types of shifts apart is not easy; neither is assessing the magnitude of their impact on the economy."

Historically the Reserve Bank had pre-empted future inflation pressures, Mr Tuffley said.

The cyclical nature of the economy meant periods of low interest rates and exchange rates would eventually boost the economy, leading to rising inflation.

Now, the Reserve Bank's two pre-emptive rate hikes earlier this year -- lifting the OCR from its record low 2.5 percent -- looked unnecessary.

Other influences beyond the usual cyclical influences were having a strong effect, and the Reserve Bank had been increasingly grappling with the policy implications of shifts in bank funding costs and shifts in borrowing behaviour, Mr Tuffley said.

The policy challenge was about how long-lasting those shifts would be.

"People are learning that house prices are not a one-way bet to riches, that debt has pitfalls as well as benefits.

"The Government will also be driving behavioural shifts in the economy to encourage more private saving and better use of the country's financial capital -- shifts intended to be structural."

The Reserve Bank now wanted to be more confident the recovery was firmly under way and that inflation pressures were rising before lifting the OCR further, Mr Tuffley said.

The Reserve Bank did note in its September MPS that it expected low interest rates to have a less stimulatory effect on the economy than had historically been the case.

Developments since then suggested current interest rates were offering even less support than had been assumed three months ago, today's MPS said.

Despite the floating mortgage rate being below its historic norm, activity in the housing market had weakened further, with the level of house sales consistent with further declines in house prices in the coming months.

Businesses remained reluctant to invest even as the interest rates faced by corporate borrowers were close to the historic average.

"It would seem firms would prefer not to increase debt at the moment, with many preferring to hire additional staff rather than make the more significant financial commitment required to purchase new capital equipment," the MPS said.

Divergence between hiring and investment intentions was large by historic standards.

"It is not clear how persistent household and business caution will be."

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