New Zealand Leaves Key Interest Rate at Record High (Update2)

By Tracy Withers

Oct. 25 (Bloomberg) -- New Zealand's central bank left its benchmark interest rate unchanged at 8.25 percent, saying record-high borrowing costs haven't yet stemmed inflation.

``The labor market remains tight, domestic income growth continues to expand on the back of strong commodity prices and core inflationary pressures persist,'' Reserve Bank Governor Alan Bollard said in a statement released in Wellington today.

Bollard, who raised interest rates four times between March and July, predicts inflation will be at the top of the 1 percent-to-3 percent band he targets until late 2009. Keeping rates high helps underpin demand for the New Zealand dollar, a favorite for the carry trade where funds are borrowed cheaply in yen and invested in higher-yielding currencies.

``It's a case of the Reserve Bank being still worried about inflation, not panicking yet, but certainly easing is a long way off,'' said Khoon Goh, economist at ANZ National Bank Ltd. in Wellington. ``Ultimately the yield remains very supportive of the currency, there's no doubt about that.''

The New Zealand dollar bought 75.47 U.S. cents at 9:45 a.m. in Wellington from 75.42 cents immediately before the statement.

The currency has gained 14 percent against the U.S. dollar and 9.4 percent versus the yen in the past 12 months. New Zealand's benchmark is 7.75 percentage points higher than Japan's and 3.5 points above the Federal Reserve's target.

``The New Zealand dollar remains relatively high, restraining the externally focused sector of the economy,'' Bollard said today.

Exports such as dairy products, meat and wool make up 30 percent of the $102 billion economy. Tourism accounts for about 10 percent.

Fiscal Policy

The current benchmark rate is consistent with the inflation target, Bollard said. Still, government spending or tax cuts, rising world food prices and the direct effects of a proposed emissions trading plan are risks to inflation, he said.

``Despite ongoing surpluses in the government's operating balance, fiscal policy is contributing to inflationary pressure,'' Bollard said. ``Any further easing in fiscal policy beyond that already announced will add further upside risks to medium-term inflation.''

Finance Minister Michael Cullen runs a budget surplus which he says drains demand from the economy. He has increased payments to families, provided tax incentives to save and will cut company taxes from April 1.

Tax Cuts

On Oct. 10, Cullen said there was ``headroom'' in the government's budgets to cut income taxes before next year's general election.

Last month, Bollard forecast annual inflation will accelerate to 3 percent by the end of 2007 and be 3.1 percent a year later. Inflation will slow to 2.6 percent by the end of 2009, he predicted.

Consumer prices rose 1.8 percent in the year ended Sept. 30, held down by a slump in gasoline prices late last year and government policies which cut the cost of childcare and visits to doctors.

The outlook for the economy and interest rates is ``broadly consistent'' with the September outlook, Bollard said today.

Record fuel and commodity prices are underpinning inflation, and the New Zealand dollar's 6.4 percent fall against the U.S. dollar the past three months makes imports even more expensive.

Milk Soars

World dairy prices have more than doubled the past year, prompting suppliers to raise the price of cheese and butter in local stores. Egg and bacon prices are rising as the cost of feed increases. Gasoline prices have jumped 9.8 percent this year as crude oil reached a record last week.

New Zealand's jobless rate fell to 3.6 percent in the second quarter, and could drop further. About 44 percent of firms surveyed by the New Zealand Institute of Economic Research last month said it was harder to find skilled workers, adding to signs that wages may increase to attract and retain staff.

Record-high world prices for products such as milk powder, cheese and yoghurt will also buoy the incomes of dairy farmers, which may fan spending.

Auckland-based Fonterra Cooperative Group Ltd., the world's biggest exporter of dairy products, will pay its 10,900 farmers about NZ$2.6 billion ($2 billion) more for milk this season.

All 15 economists surveyed by Bloomberg News forecast today's decision. Twelve expect no change in rates until at least July, two forecast a cut and one predicts two increases.

Central Banks

Central banks around the world have been reluctant to raise borrowing costs as they assess whether the U.S. subprime mortgage rout will derail global economic growth.

The Reserve Bank of Australia kept its benchmark rate at 6.5 percent. The Federal Reserve cut its benchmark by 0.5 percentage points to 4.75 percent and may cut by another quarter point on Oct. 31, according to futures markets.

``Considerable uncertainty remains'' in world markets, Bollard said. ``This poses a downside risk for our key trading partner economies.''

Evidence is mounting that consumer spending and housing demand are slowing as home-loan interest rates increase. The rate on a two-year mortgage averaged 9.2 percent in August from 8.1 percent a year earlier, according to central bank figures.

``There are signs the housing market is moderating,'' Bollard said.

House sales had their biggest annual decline in more than nine years in September, according to the Real Estate Institute.

Retail sales rose in August at the half the pace expected. Annual immigration was at a 19-month low in September, which may further curb demand.