15 Mar 2013

Drought factor in Reserve Bank further holding OCR

7:08 am on 15 March 2013

The Reserve Bank has signalled interest rates are on hold for longer after adding the impact of the drought on economic activity to the mix.

As expected, the Reserve Bank held interest rates on hold at its record low of 2.5%, citing an uneven economic recovery, with demand and production expanding but unemployment remaining persistently high.

Reserve Bank governor Graeme Wheeler highlighted rising house prices in Auckland could push up inflation, but he also noted the overvalued New Zealand dollar and the current drought could dampen growth.

First NZ Capital director of economics and strategy Chris Green says uncertainty over the severity of the drought has weighed on the central bank.

He says looking forward the drought looms over other issues such as the overvalued currency, the housing front and slightly more positive domestic activity.

Mr Green says it was alluded to that if the drought conditions persist, it could result in a significant change to the New Zealand economic profile.

He says historically drought has been a key determinant of New Zealand's economic prospects because it is still an agriculturally based economy dependant on the rain.

Mr Green says the impact of the drought in 2007 - 2008 was significant and estimated at around $2.8 billion.

He says at this stage the drought is estimated to cost $1 billion, but if the drought intensifies the economic impact could be significantly greater.

A Reuters news agency poll now shows a clear majority of analysts are picking interest rates to rise in the first quarter of next year, most likely in March.

Prediction kiwi will continue falling

A currency strategist is expecting the dollar to continue falling, as the realisation sinks in that interest rates will remain on hold until at least the end of the year, and the possibility that the next move may even be a cut.

The kiwi fell to 0.75 cents against its American counterpart to below 82 US cents after the Reserve Bank decision.

Despite recent predictions that the dollar will peak as high as 90 US cents this year, BNZ currency strategist Mike Jones says it's more likely that the kiwi will fall.