The Reserve Bank today pushed official interest rates to their lowest level in five years, slashing them by a remarkable 1.5 percentage points to 5%.
The central bank presented a grim picture of the economy caught up in global financial turmoil, while sounding largely relaxed about inflation risks, as well as indicating that today's interest rate decision would be the last big cut.
Reserve Bank Governor Alan Bollard said ongoing financial market turmoil and a marked deterioration in the outlook for global growth played a large role in today's decision.
Activity in most of New Zealand's trading partners was expected to contract or grow only very slowly in the next few quarters, meaning economic activity in this country would be further constrained than the Reserve Bank thought it would be in October.
In a clear message to lenders, Dr Bollard said the Reserve Bank expected financial institutions to play their part in the economic adjustment process by passing on lower wholesale interest rates to their customers.
The Reserve Bank acknowledged that recent falls in wholesale interest rates had resulted in "markedly" lower mortgage interest rates offered to new borrowers and households re-pricing existing debt.
Today's decision brings the cumulative reduction in the official cash rate (OCR) since July to 3.25%age points.
Dr Bollard said it was appropriate to have delivered the reduction quickly to support the economy and keep inflation from falling below the target band of 1 to 3%.
Annual inflation hit 5.1% in the September quarter, underpinned by high petrol and food price inflation, but the Reserve Bank now expects it to decline markedly.
Some time in the first half of 2009 annual inflation is expected to return comfortably inside the target band and to stay there for the medium term.
Recent petrol price declines were expected to help drive annual headline inflation to briefly fall to 1.6% in the September quarter of next year, the Reserve Bank said in its December Monetary Policy Statement (MPS) published today.
Despite that, the Reserve Bank continues to have concerns about domestically generated inflation, due particularly to electricity prices and local body rates.
"Balancing the various risks around the outlook, we assess some further, but significantly smaller, reductions in interest rates may be warranted beyond the current policy decision," the MPS said.
Prices for several of this country's commodity exports had fallen significantly and were likely to fall further.
New Zealand-based banks and large firms were also finding it difficult to access traditional overseas funding sources as well as paying a higher margin for what they could get.
"Both of these forces will act to lower growth and inflation," the MPS said.
Gross domestic product was expected to have contracted further in the September quarter, the third consecutive quarterly decline, and further quarters of negative growth in early 2009 were "quite possible".
Employment was expected to decline in the coming year and then show only sluggish growth, the MPS said.
Despite that, the Reserve Bank is expecting the unemployment rate peak to be "quite modest" relative to previous cycles, reaching 6% by the end of 2009 before declining.
That was because of the current low level of unemployment, along with muted net immigration going forward.
But the MPS also said that while the Reserve Bank expected sizable declines in employment and investment, "even sharper adjustments are possible".
The number of tourists visiting New Zealand was expected to decline further in the coming year, although the near-term outlook for merchandise exports was less clear.
Assuming the weather remained favourable, dairy export volumes were likely to continue to recover from last season's drought-inhibited levels, but meat export volumes were expected to decline as farmers looked to rebuild depleted breeding stocks.
Forestry export volumes were likely to continue to be inhibited by weak housing construction in most countries.
