Bank pricing doing the work of monetary policy

The Reserve Bank of New Zealand yesterday left the Official Cash Rate unchanged at 2.5 per cent but warned that a rise, when it happens, will have a greater impact on the economy.

"Because of increased bank funding costs, a shortening in mortgage duration and a positively sloping yield curve, we expect this tightening to have quite a powerful and relatively immediate impact on the economy," RBNZ wrote in the monetary policy statement published yesterday.

The RBNZ stuck to its previous stance that it continues to expect to begin removing policy stimulus around the middle of 2010.

Alan Bollard, governor of the RBNZ, would not be drawn at a media briefing into indicating whether around the middle of 2010 meant a rate rise could happen at the next review of the cash rate, due at the end of April.

The RBNZ has been able to resist hiking its OCR because financial conditions are much tighter than is normally associated with an OCR at 2.5 per cent. Its own estimates suggest that marginal cost of bank funding has increased to about 150 basis points above the OCR, from around 20 to 30 basis points before the financial crisis.

In February 2009, when the OCR was at 3.50 per cent, the six-month deposit rate offered by banks was at 3.79 per cent. A year later, the OCR dropped to 2.50 per cent but the six-month deposit rate has increased to 4.38 per cent.

From a low of 10.5 basis points in spread between the six-month bill rate and the deposit rate in December 2008, the spread has widened to around 136 basis points in January 2010. The spread was at 89.5 basis points in January last year.

Similarly, when the OCR was at 8.00 per cent in August 2008, the floating mortgage rate offered was 10.7 per cent and the two-year fixed mortgage rate was at 9.00 per cent. With the OCR dropping 550 basis points to 2.50 per cent, the floating rate fell to 6.2 per cent and the fixed rate eased just 170 basis points to 7.3 per cent.

The RBNZ is expecting that trend to continue and believes this will reduce the need to increase the OCR to achieve a desired level of interest rates.

The RBNZ expects annual CPI to touch 2.0 per cent in December, compared with its assessment of 1.4 per cent in the December policy statement. By December 2011, annual CPI is expected to touch 2.8 per cent, up from a previous assessment of 2.6 per cent.