The central bank will need to indicate at least one further reduction and commit to ongoing rate cuts if need be. According to BNZ economists, only then does the Reserve Bank stand any chance of keeping the New Zealand dollar in check. Currently, that is all it can hope for in a world where central banks seem to have less and less impact on economic outcomes.
Reserve Bank governor Graeme Wheeler is widely tipped to cut the OCR tomorrow, following the lead of the Australian and British central banks.
The United States is the only developed country in the world now considering raising its lending rate but then, its rate is still 0.25%.
Mr Wheeler desperately wants housing prices to fall and for the dollar to fall alongside it. Exporters continue to hurt when the dollar rises against New Zealand's main trading partners, particularly Australia, China and the United States. Cutting the OCR will be the behind-the-scenes reasoning for the cut and the official reason will be inflation seriously lagging behind the bank's 1% to 3% policy target agreement with the Government.
The first problem for the Reserve Bank on inflation was the second-quarter CPI result which at 0.4% proved to be 0.2% lower than the 0.6% forecast. The king hit is likely to be in the third-quarter result which, largely thanks to a slump in petrol prices, could be much lower than the bank's June Monetary Policy Statement. At that time, the Reserve Bank was picking 0.5% at a time when economists are now picking -0.1%. New Zealand is dangerously close to a recession.
If the Reserve Bank's problems are not yet bad enough, the dollar continues to strengthen. The average level of the trade-weighted index - a basket of currencies of New Zealand's trading partners - for this quarter is 76.3 compared to the Reserve Bank's assumption of 71.6. If all things were equal, the 6.6% difference would demand a savage cut in the cash rate - down to near zero.
The biggest argument against lowering interest rates has been the stimulation they have provided to the already overheated housing market. There is still a constituency for leaving interest rates on hold because the continued broad-based strengthening of the housing market across New Zealand poses a risk to financial stability. However, the Reserve Bank is looking to address this through further macro-prudential measures. The new measures are estimated to take 2% to 5% off annual house price inflation. If the Reserve Bank is confident with its forecasts, there will be no reason to change its already-produced house price inflation forecasts.
Moreover, it very unlikely retail banks will pass on the full 0.25% points of OCR reductions to home mortgages.
The New Zealand central bank can take some lessons from rate cuts last week. The Reserve Bank of Australia cut rates but remained non-committal for further rate cuts. As a result, the Australian dollar eventually lifted against the US currency later in the week. The Bank of England painted more of ``whatever it takes'' tone, which successfully helped the British pound remain anchored.
Mr Wheeler, and his associates, need to indicate clearly tomorrow their intentions for the future. A risk of holding rates means a rising dollar hurting exporters. The exchange reflects the truth of the New Zealand economy growing more strongly than most.
Housing price inflation is its own problem and cutting the cash rate will exacerbate the situation.
Further rate reductions are not needed in New Zealand until such time the economy shows definitive signs of slowing. Then, and only then, does it make sense to use measures that have an outside chance of working.
