New Zealand Central Bank Holds Rates, Softens Tone

New Zealand's central bank kept interest rates steady at 8.25 percent as expected on Thursday, but softened its stance on an eventual rate cut as the economy slows, sending the currency lower.

The Reserve Bank of New Zealand said the economy was slowing more than expected, although it stuck to its previous script that inflation pressures remained persistent from high oil and food prices, and other sources.

It expected rates to stay on hold for some time yet, but analysts noted it had dropped the phrase "significant time" used in the March statement.

"It suggests we are starting to see the Reserve Bank's stance shift a little bit, and it looks a bit more likely the bank could be cutting by the end of the year, instead of holding off until next year," said ASB Bank chief economist Nick Tuffley.

The New Zealand dollar extended initial losses to settle around half a cent lower at $0.7930/40 in the Asian session.

Bank bills rallied with the yield on the December contract 10 basis points lower at 8.32 percent.

All 17 analysts surveyed by Reuters had expected the central bank to leave rates on hold, with a median risk for a 25 basis point cut put at just 10 percent.

New Zealand's cash rate is the highest in the industrialized world, but has been on hold since the middle of last year as other key global rates, including those in the United States and some other G7 nations, have been cut to stave off the effects of the global credit crisis.

New Zealand's central bank said financial market turbulence was continuing to add uncertainties to the weaker global outlook, while domestic activity was slowing more than expected as the housing market rapidly cooled following four interest rate increases last year.

"We see significant downside risks to future activity but upside risks to inflation," central bank governor, Alan Bollard, said in a statement. "Given this outlook, we expect that the OCR (official cash rate) will need to remain at current levels for a time yet to ensure inflation outcomes of 1 to 3 percent on average over the medium term."

Evidence is mounting that the New Zealand economy is slowing down. It expanded 3.1 percent in 2007 but analysts expect growth this year of 1.7 percent.

House price inflation eased for the seventh straight month in March, while the number of house sales has fallen dramatically, down 53 percent on a year earlier.

Retail sales stalled in February; manufacturing activity contracted in March to its lowest level since late 2005; business confidence fell to a 33-year low in the NZ Institute of Economic Research's quarterly survey; and consumer confidence was at a 10 year-low in the first quarter.

Still, the central bank said inflation remained a threat, pointing to a tight labor market, looser government spending and surging food and oil prices.

Bollard said there was a risk that short term price shocks from rising food and oil costs, which the central bank has said it would look through, could lead to higher wage growth and perpetuate inflation pressures.

Data showed last week that annual inflation hit its highest level in 18 months at 3.4 percent in the first quarter, driven by higher fuel and food prices.

The central bank has forecast inflation will stay above its 1-3 percent target band until mid-2009. The latest Reuters poll showed 11 of 17 forecasters expected a rate cut by the end of 2008.

Financial markets are pricing in a 40 percent chance of a rate cut by the end of the year, and some expect that the central bank will need to start cutting aggressively.