February 7, 2018 / 9:08 PM / a year ago

UPDATE 2-New Zealand's central bank holds rates, says volatility a warning

* RBNZ says equity market swings did not alter forecasts

* Says markets have settled, sees no long term effect

* Sees volatility as nerves over rate normalisation (Adds detail, commentary)

By Charlotte Greenfield and John Mair

WELLINGTON, Feb 8 (Reuters) - New Zealand’s central bank kept interest rates steady at a record low on Thursday and said volatility in equity markets this week was a warning sign that global markets are nervous about the risk of higher inflation and rising interest rates.

The Reserve Bank of New Zealand held its cash rate at 1.75 percent and lowered its forecasts for inflation right out to 2020, suggesting investors need not fear the withdrawal of stimulus for a long time to come.

That dovish slant pushed the local dollar down around half a U.S. cent to a one-month low of $0.7209. It was last trading at $0.7225.

Bank bill futures were little changed as the RBNZ’s interest rate projections were unchanged.

RBNZ Governor Grant Spencer said wild stock market swings over the past week had not changed any forecasts.

“The bond market didn’t really react, it’s more of an equity market phenomenon. And now it’s settled down, so that’s not really going to have a long term effect,” Spencer said.

“But you’d have to say it’s been a warning sign because that volatility shows how nervous the market is about...the normalisation of interest rates.

“Currently the market’s expecting it to be gradual. If it was sharper you’d have more volatility down the track.”

The RBNZ remained upbeat on domestic growth, saying the output gap was around zero and that the labour market was near full employment. The output gap measures the economy’s actual output versus its maximum potential.

Spencer said he was comfortable with the level of the NZ dollar after its recent gains against the U.S. dollar and in trade-weighted terms.

Consumer price inflation for the December quarter undershot all expectations at just 1.6 percent when the RBNZ had hoped it would be nearer 2 percent, the middle of its 1-3 percent target band.

As a result, the bank had to lower its inflation forecasts for the next two years, with 2.0 percent now not reached until the third quarter of 2020.

“It is a justifiably dovish statement,” said Ben Jarman, a senior economist at JPMorgan in Sydney. “The recent reading on inflation has been on the downside.”

“It takes a lot longer to go back to 2 percent on inflation,” said Jarman. “If you look at the very near term it’s down quite a lot.”

Reporting by Charlotte Greenfield and John Mair; Editing by Richard Balmforth and Eric Meijer

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