October 23 OCR Review: RBNZ Meets Expectations with a 100bp Cut

Facing Reality

• The RBNZ cut the OCR by 100bp, as we and the market expected.
• The global economic picture has deteriorated in recent weeks, and is likely to get worse before it gets better.
• Further rate cuts are on the way, but the RBNZ will be more cautious about large moves as monetary policy starts to move into 'easy' territory.

It's a sign of the extraordinary times we live in that a 100bp rate cut was the least controversial move that the RBNZ could have made today. Conditions have shifted rapidly since the September Monetary Policy Statement - efforts by policymakers seem to have pulled the global financial system out of its tailspin, but the economic picture is likely to get much worse before it gets better. Domestic conditions alone warranted a rate cut today; the risk of more financial turmoil to come suggested a large move as a precautionary move. In the end, the RBNZ played it with a straight bat and delivered what we and the majority of the market were expecting.

The RBNZ made it clear that they intend to ease further, with the only questions being when and how much. Indeed, it would be a brave central bank who declared an end to the easing cycle while the news on the global economy continued to deteriorate. But at the same time, they were quick to hose down any suggestion that today's jumbo-sized move was a sign of things to come.

One point to consider is that with a 90-day rate of 7.10%, monetary policy is now much closer to the RBNZ's notion of 'neutral', and further rate cuts will soon put into genuinely 'loose' territory. That could well be appropriate in the circumstances, but the RBNZ will be aware that each additional rate cut from here on is one that will eventually have to be reversed.

Hence the renewed focus on inflation, which was noticeably AWOL in the September statement. That focus will have been partly fuelled by Tuesday's CPI figures - a headline annual rate of 5.1% is bad enough, but the RBNZ will be particularly concerned with the breadth of price increases, and the persistence of domestically-driven inflation. Some of the factors the RBNZ singled out in today's statement, such as local body rates and electricity prices, are arguably beyond the reach of monetary policy. But when they consistently rise by 3% or more each year, the RBNZ has to reduce inflation elsewhere in order to meet their overall inflation target - something they would rather not do right now. This won't prevent further easing in coming months; rather, it's a reminder to the market that there are constraints on how much the RBNZ will deliver at any one time.

The exchange rate doesn't seem to be one of those constraints, though, unlike in the previous two statements. If anything, the RBNZ views the weaker currency as more of a help than a hindrance, as it is helping to soften the blow of lower commodity export prices and weaker world demand. RBNZ Governor Bollard noted in the press conference that the exchange rate has been "well behaved"; we'd agree at least that the currency's response has been appropriate to the circumstances.

Market implications

Today's decision has not changed our view that the RBNZ will cut by 50bp at the December MPS and another 50bp in the March quarter, reaching a trough of 5.50%. However, world economic conditions remain extremely fluid, and so will our OCR forecasts. We expect market pricing to continue to run well ahead of RBNZ action, and in coming months will probably factor in a trough in the OCR of 4.50-4.75%.

The NZD rose around 1 cent to 0.5930 on the announcement. As with the RBA's 100bp cut earlier this month, the market's first instinct appears to have been to reward the currency for such a proactive move by the central bank. But today's reaction is likely to be swamped by tonight's offshore developments.

Full RBNZ press release

The Reserve Bank today reduced the Official Cash Rate (OCR) from 7.5 percent to 6.5 percent.

Reserve Bank Governor Alan Bollard commented that "ongoing financial market turmoil and a deteriorating outlook for global growth have played a large role in shaping today's decision.

"Economic activity in New Zealand will be further constrained, relative to the outlook presented in our September Monetary Policy Statement, by these international developments. New Zealand can expect to face lower demand for exports and credit is likely to be less readily available. In this environment consumers and businesses are likely to be more cautious and curtail spending.

"The reduction in domestic spending will be partly offset by the depreciation of the New Zealand dollar over the past few months, falling oil prices and the recent loosening of fiscal policy.

"With weaker short-term growth and sharply lower oil prices we now expect that annual CPI inflation will return to the target band of 1 to 3 percent around the middle of 2009. However, we still have concerns that domestically generated inflation (particularly in labour costs, local body rates, electricity prices and construction costs) is remaining stubbornly high.

"Consistent with the Policy Targets Agreement, the Bank's focus will remain on medium-term inflation. Should the outlook for inflation evolve as projected we would expect to lower the OCR further. However, the timing and extent of OCR reductions over the coming months will depend on evidence of actual reductions in domestic cost pressures as well as how the global financial developments play out."

Westpac Institutional Bank

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