New Zealand’s Reserve Bank kept its key interest rate – the official cash rate (OCR) – steady at 8.25% this morning.

The bank governor, Alan Bollard, indicated he would reduce interest rates later this year, saying:

“Provided the economy evolves in line with our projection, we are now likely to be in a position to lower the OCR later this year.”

The bank believes that interest rates are currently above neutral but will not reduce them until it is confident that “medium-term inflation pressures are easing”.

Dr. Bollard’s statement resulted in an immediate fall in the value of the New Zealand dollar, heartening both exporters and migrants seeking to shift funds to New Zealand. The Reserve Bank commented that the NZ dollar had been falling in value recently, and that there is a risk it could now fall at a faster.

Less heartening news is the Reserve Bank’s view that a recession is possible, although not officially forecast.

“We project little GDP growth over 2008, and only a modest recovery thereafter, largely reflecting a weaker household sector. Government spending and personal tax cuts will provide some offset to this lower growth but will also add to medium-term inflation pressure.”

Dr. Bollard said that New Zealand is now facing a “challenging environment of weak activity and high inflation”.

He expects inflation, measured by the CPI, to peak at 4.7% this year before returning to the target 1 to 3% band in the medium-term.

Wellington Chamber of Commerce CEO Charles Finny welcomed the Reserve Bank’s statement, saying:

“While many businesses will be disappointed that there was no reduction today, the statement shows that there is light at the end of the tunnel.

“High interest rates are amongst our members’ most commonly cited concerns and today’s statement, as well as the financial market’s reaction, will provide a much needed boost to business confidence.

“As the economy weakens and inflationary pressures subside, we believe the case is building for the Reserve Bank to cut the OCR as early as September and we will be watching developments closely.”

International Comparison of Interest Rates