Reserve Bank presages cut

Jane Turner.
Jane Turner.
The country's official cash rate (OCR) could well be below 2% by the end of the year, as the Reserve Bank has reaffirmed meeting its inflation target range of 1%-3% is its primary focus.

In an unscheduled economic update from the Reserve Bank yesterday, it emphasised the high exchange rate was adding further pressure to the beleaguered dairy and manufacturing sectors.

The New Zealand dollar against the greenback traded above US72c for much of last week, before easing to US70c, and dipped down to US69.7c following yesterday's announcement.

Inflation is at present stubbornly sitting at 0.4% for the Reserve Bank.

While just 0.4% inflation might on the face of it be attractive to consumers, the low rate stifles business growth, in turn undermining employment and eventually eroding consumer spending.

The Reserve Bank statement said: "At this stage, it seems likely that further policy easing will be required to ensure that future average inflation settles near the middle of the target range.''

The Reserve Bank remains between a rock and a hard place.

If it cuts the OCR further, that could fuel the escalating housing price crisis, but with New Zealand having one of the highest interest rates in the world, that is attracting investors and strengthening the dollar, to the detriment of exporters.

Whether further cuts to the already record low 2.25% OCR get passed on to bank customers remains unclear.

ASB senior economist Jane Turner said the Reserve Bank made very strong comments about the strength of the New Zealand dollar, quoting the bank saying "it makes it difficult for the bank to meet its inflation objective''; which is midway of its target range of 1%-3%.

"The Reserve Bank explicitly stated a decline in the exchange rate is needed,'' Mrs Turner said.

Earlier this week the Reserve Bank raised the bar for housing investors and speculators, increasing the loan to value restrictions (LVR) from requiring a 30% deposit for Auckland investors, to 40% for all investors throughout the country.

Mrs Turner said the central bank had been reluctant to cut the OCR further, due to financial stability risks, but its changes this week to the LVR had assisted it.

The Reserve Bank said house price inflation remained "excessive'' and has become more broad-based across the regions, adding to concerns about financial stability.

"The bank is currently consulting on stronger macro-prudential measures aimed at mitigating risks to financial stability from the current boom in house prices,'' it said.

Mrs Turner believes the Reserve Bank will cut the OCR to 2% in August and to 1.75% in November, while Westpac acting chief economist Michael Gordon also picked to 2% in August "with the door open'' to further cuts.

"The domestic economy remains in reasonable shape, supported by population growth, construction, tourism and low interest rates.

"However, risks around the global economy are seen to have increased, particularly after the UK vote to leave the European Union,'' Mr Gordon said.

He said recent Reserve Bank statements had left the market with the mistaken impression the strong housing market could prevent interest rates being eased further, but yesterday's statement was "clearly arranged'' to dispel that view.

The markets have almost doubled expectations the Reserve Bank will cut the OCR next month, following its imposition of new "speed limits'' this week on housing investors.

Craigs Investment Partner broker Peter McIntyre said the market interpreted the Reserve Bank's moves of increasing the loan to value restrictions (LVR) as "paving the way'' for further OCR cuts, from the present record low 2.25%.

In a surprise move on Tuesday, which had not been expected to be announced until the end of the year, the Reserve Bank announced a proposal housing investors must now have a 40% deposit for a property, which would now apply to all investors across the country, and not just those in Auckland.

Owner-occupiers need 20% and those building a new homes are exempt.

Mr McIntyre said market pricing now implied a 75% chance of a 0.25% cut being announced at the August meeting, compared with less than a 40% chance 11 days ago.

simon.hartley@odt.co.nz

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