Another Big New Zealand Rate Cut Expected

December 2, 2008

Opinion is split over whether the Reserve Bank of New Zealand will slash its 6.5% cash rate to 5.5% or 5.0%. The announcement will be made at 02:00 GMT Thursday (09:00 local time and 21:00 Eastern Standard Time Wednesday in the United States). Like Australia, this will be the fourth reduction in this easing cycle. New Zealand’s first was a 25-basis point move from 8.25%, which had prevailed for 12 months until July 24th. A second move on September 11th doubled the magnitude to 50 basis points, and the size was doubled again to 100 basis points on October 23rd. The last cyclical low was at 5.0% occurred between July 2003 and January 2004. The RBNZ’s next scheduled interest rate policy meeting will be on January 29th.

The central bank statement released on October 23rd cut the inflation forecast due to a recession and falling oil prices, moving the timing for a likely return to in-target levels forward to mid-2009 from early 2010. That report observed a “marked” slowdown in consumption, continuing global financial turmoil, and tight local credit conditions.

New Zealand posted consecutive quarters of negative growth in the first half, but the dips were small at 0.3% in 1Q followed by 0.2% in 2Q. The sharpness of the recession escalated after mid-2008 and should be particularly pronounced in the current quarter. Growth in calendar 2009 is likely to be minus 1.0% or worse. Real retail sales fell 0.9% last quarter and by 3.6% in the year to 3Q08. Home sales are falling, and house prices are soft. Business sentiment fell in November to -43.0 from -42.3 despite October’s greater-than-expected rate cut. Household credit demand is weaker than anytime in the past 17 or more years. Weak exports and consumption have crunched investment spending. Fiscal policy is being loosened.

Consumer price inflation was still cresting in the third quarter at 5.1%, an 18-year high, and both producer price inflation and labor cost increases last quarter also exceeded forecasts. One source of price pressure has been the floundering kiwi, which is 28.4% weaker against the U.S. dollar compared to July 24th, when the first central bank rate cut was made. A central bank survey of expected inflation found such to be safely below the 3% target ceiling over both a 1-year and 2-year time horizon.

RBNZ Governor Bollard attempted to squelch speculation of continuing large rate cuts after the October reduction, but global and domestic economic circumstances are more dire now than then. Neighboring Australia set an example of boldness in monetary policy making today. However, Bollard could match the RBA’s cut of 100 basis points and not lose faith. Also, he seems a little more worried about exchange rate losses than his Aussie counterparts. I tip the balance of risk toward a rate cut of 125 basis points, rather than 100 bps, but only by a very thin margin.

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