By Charlotte Greenfield and John Mair
WELLINGTON (Reuters) - New Zealand's central bank unexpectedly committed to keep interest rates at record lows through to 2020 and said it was worried about persistently disappointing growth, a dovish tilt that sent the local currency skidding to multi-year lows.
The Reserve Bank of New Zealand (RBNZ) downgraded its forecasts for 2019 gross domestic product (GDP) growth to 2.6 percent from 3.1 percent earlier as it kept its official cash rate on hold at 1.75 percent in a widely expected move.
The RBNZ now sees the cash rate steady for much longer than earlier forecast, signalling stable rates until late 2020. Back in May, the central bank had projected rates at 2.0 percent by March 2020.
"On balance, we just need to be continuing to make sure that we are blowing wind into the sails of the economy for some time yet," Governor Adrian Orr told Reuters.
"And in fact, if you saw a deterioration in growth, i.e. a non response, then we might have to blow more wind."
The dovish policy slant caught markets off guard, and the New Zealand dollar fell sharply to a trough of $0.6665, its lowest in nearly 2-1/2 years, having traded above $0.6750 on Wednesday.
"The RBNZ has very consciously sent a message that they have become more dovish in the past six weeks," economists at ANZ Bank said in a report.
The rates outlook was significantly more cautious than financial markets had bargained for. Before Thursday's meeting, they were pricing in a full 25 basis point hike to 2.0 percent by the middle of next year.
Orr said the central bank's growth forecasts had proven too optimistic over the past 18 months, and it was sensitive to further downward surprises. In contrast, while inflation was edging towards the 2 percent midpoint of the RBNZ's target, it was well contained and unlikely to surge.
The economy hit a soft patch earlier this year and business confidence has sunk to decade lows, raising concerns a slowdown in business investment could further dent domestic activity.
"That's our number one downside risk... that people talk themselves into not investing," Orr said.
The economy expanded at an annual rate of 2.7 percent in the first quarter from 2.8 percent at the end of 2017, and is below a recent peak of 3.3 percent in 2017.
"The main message for the Reserve Bank was one of heightened uncertainty, as downside risks prevail," Kiwibank economists said in a report, calling the RBNZ's projections "blatantly dovish".
"It's time to watch, worry and wait."
WELL-BEHAVED KIWI
Orr said the New Zealand dollar's recent fall was consistent with its modelling around interest rate and inflation differentials, and was near what the central bank calculated to be fair value. It was projected to weaken further in trade-weighted terms, with the gap to the U.S. Federal funds rate set to widen.
"I mentioned that I have been really pleased with how the exchange rate has been behaving, because effectively it's been doing what it's meant to do, which is reflect the relative expected inflation differentials between two currencies."
However, the currency's sharp drop on the more dovish central bank tone took its losses against the U.S. dollar this year to 6 percent.
Kiwibank economists cut their year-end and mid-2019 forecasts for the currency by four cents to $0.65 and $0.63 respectively.
Orr said while the escalating trade war between the United States and China was attracting a lot of attention, so far the impact on New Zealand, which is an open trade-dependent economy, was not large - but that could change.
"It's a very hard thing to model, we had a crack at it, and the answer is from what we've seen to date it doesn't make a huge difference," he said.
"But it could get bigger, and/or it could impact global business confidence."
(Reporting by Charlotte Greenfield and John Mair in WELLINGTON, Wayne Cole and Swati Pandey in SYDNEY; Editing by Sandra Maler & Shri Navaratnam)
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