26 Jul 2008

Reserve Bank cuts interest rate to 8%

6:30 am on 26 July 2008

The Reserve Bank of New Zealand cut the Official Cash Rate to 8% on Thursday as the domestic economy slows. It was the first cut in five years.

The former rate of 8.25% was set on 26 July 2007. Inflation is currently 4% and the economy contracted 0.3% in the March quarter.

Reserve Bank Governor Allan Bollard said on Thursday that "there is a risk that the domestic economy will slow further" over the rest of the year.

The Reserve Bank said significant pay rises would be unlikely, despite the rising cost of living and is predicting 5% inflation by September.

But the Council of Trade Unions says businesses are doing well enough to sustain 3% and 4% pay rises across the board.

Business New Zealand says the decision to lower the Official Cash Rate will provide little relief for exporters.

Spokesperson John Pask says the New Zealand dollar has fallen slightly on the back of the drop in the cash rate. But he says any increased returns for exporters may be of little comfort.

Mr Pask says the Reserve Bank's decision is likely to push up the cost of oil and other imports, cutting into exporters' bottom lines. He says that is especially true for exporters who have to buy in materials from overseas.

The Importers Institute says the interest rate cut will make it tougher for consumers to stretch their income this Christmas, as it will push up the price of imported items.

The institute is predicting a greater fall in the New Zealand dollar in the next two weeks. Its secretary, Daniel Silva, says that will push up costs for importers currently ordering Christmas stock and increases of more than 10% could be passed to consumers.

Reserve Bank statement

The Reserve Bank on Thursday reduced the Official Cash Rate from 8.25% to 8%. Reserve Bank Governor Alan Bollard commented that:

"More unpleasant international news has emerged since the June Monetary Policy Statement, and there is a risk that the domestic economy will slow further.

"Moreover, the cost of funds raised abroad by banks has been rising in recent months as the international financial situation has deteriorated. Today's cut will help to mitigate the effect of these increases on the actual borrowing costs paid by firms and households.

"Recent oil and food price increases mean that annual CPI inflation should peak around 5% in the September quarter of this year.

"However, we expect that inflation will return inside the target band in the medium term. The weaker economy is expected to reduce pressure on resources, making it more difficult for firms to pass on costs and for higher wage claims to be agreed.

"Economic activity is likely to remain weak over the remainder of 2008.

The ongoing correction in the housing market, together with the very high oil prices, will limit household spending and constrain the extent of recovery. However, high export prices and an expansionary fiscal policy are expected to contribute to a gradual pickup in activity through 2009.

"Consistent with the Policy Targets Agreement, the bank's focus will remain on medium-term inflation.

"In this regard, it is important to note that monetary policy has been reasonably tight for some time, and is now restraining activity and medium-term inflation pressures.

"Provided that the outlook for inflation continues to improve and there is no excessive exchange rate depreciation, we would expect to lower the OCR further."