New Zealand Cash Rate Slashed by a Whole Percentage Point

October 22, 2008

Rate cuts by the Reserve Bank of New Zealand of 25 basis points on July 24th and 50 basis points on September 11th were escalated today in another twofold jump to 100 basis points. The new cash rate of 6.5% is the lowest since early 2005 and matches the forecast of a majority of analysts. The central bank went deep in spite of a sharp depreciation in the kiwi since September 11th and CPI inflation of 5.1% in the year to 3Q08. The central bank’s statement today predicts in-target inflation, that is below 3%, by mid-2009 in contrast to a prior forecast of 3.2% in 2H09. New Zealand GDP fell in both 1Q08 and 2Q08, but today’s medicine was administered primarily in response to global financial developments that have weakened the global growth outlook. Although expressing residual concern about domestically generated inflation, the statement identifies scope for additional easing of monetary policy, provided inflation evolves as expected. The timing of future cuts will depend on how domestic cost pressures recede and the evolution of the financial crisis. Kiwi weakness was not explicitly identified as a constraint against future rate reductions.

New Zealand is not the only central bank cutting rates by large increments. The Fed went through this process in the first quarter and, with a Fed funds rate of just 1.5%, simply lacks the kind of scope for easing that central banks like the RBNZ have. While asset liquidations to cover losses and the flight of capital away from risk are the prime factors behind the rapidly strengthening dollar, the prospect of faster and deeper rate cuts outside the United States compared to cuts within the U.S. is also buoying the dollar. Related to that, some investors believe that the earlier easing by the Fed will position the U.S. economy to lead others out of the recession that everybody now shares.

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