11 Mar 2016

ANALYSIS: Why the RBNZ joined the rate cutting club

10:21 am on 11 March 2016

What a difference a month makes.

In early February, Reserve Bank Governor Graeme Wheeler sounded like he would have to be dragged screaming to cut interest rates.

Today, he has been dubbed - with a bit of tongue in cheek - "Action Man".

So what has changed?

Reserve Bank governor Graeme Wheeler

Reserve Bank governor Graeme Wheeler Photo: RNZ

Two factors stand out: the world has become a meaner and more dangerous place, and the bank fears weaker inflation expectations will get entrenched and start affecting consumer and business behaviour.

"The outlook for global growth has deteriorated since the December Monetary Policy Statement, due to weaker growth in China and other emerging markets, and slower growth in Europe," Mr Wheeler said.

"There has been a material decline in a range of inflation expectations measures. This is a concern because it increases the risk that the decline in expectations becomes self-fulfilling and subdues future inflation outcomes."

Which, along with a weak dairy sector and high New Zealand dollar, led him to say "further policy easing may be required to ensure that future average inflation settles near the middle of the target range".

Only a handful of analysts had picked a rate cut today.

Kiwi Bank senior economist Zoe Wallis was one of them.

"The weaker global growth outlook and the ramifications for New Zealand as a small open economy, and the falling inflation expectations clearly pushed them."

Ms Wallis said the RBNZ will cut again.

"We're comfortable with our view that there'll be another cut in June, and looking at their commentary the risks may be skewed to the downside from here."

ANZ Bank chief economist Cameron Bagrie had thought the RBNZ would wait until the middle of the year.

"Our view (is) that more downside risks around the globe will materialise as the year progresses, we expect more than one additional cut before year end," he said. The ANZ now expects the cash rate to be at 1.75 percent by year end.

Hot housing market not a worry

One of the main reasons given by analysts for not cutting rates this time was the stimulus it would give the housing market, but that clearly has been relegated to a list of lesser worries.

However, Mr Bagrie said the RBNZ could not afford to get complacent, given many regions outside of Auckland were picking up a head of steam.

"Auckland house price growth may have moderated, but the level of prices remains stratospheric - as does net migration. Moreover, households are leveraging up again. A lower OCR is therefore not a free lunch."

Lending rates have already started to fall in response to today's cut, but if the RBNZ gets worried about growth in prices outside of Auckland it could easily reinstitute the tougher lending restrictions it loosened last year.

One of the RBNZ's other perennial concerns - the high New Zealand dollar - was also tackled by the rate cut, with the trade-weighted currency falling more than 2 percent, although it may be short lived.

"It's hard to get overly bearish on the NZ dollar given respectable growth locally, solid yield still on offer in a yield-hungry world, and prospects for even more stimulatory policy -- a push into more negative rates -- in other parts of the globe," Mr Bagrie said.

But at least one commentator felt betrayed by the statement.

The head of research at the BNZ, Stephen Toplis, had argued there was no need for a rate cut - the nicely performing economy didn't need lower rates at this stage - and he put some faith in Mr Wheeler's February speech, which most commentators agreed poured cold water on rate cuts.

"This is the second time in two years that we have listened to a speech by Graeme Wheeler and been stupid enough to pay attention to it.

"We reiterate that the question that needs to be addressed before all else is 'is low inflation in this environment really that bad?' We don't think so," he said.

The RBNZ is forecasting the economy to grow at an annual rate of about 3 percent for the next couple of years.

But it was also picking inflation - currently at 0.1 percent in the year ended December - will crawl back to the bottom of the 1-to-3 percent target band by the end of this year but won't reach the desired midpoint until the start of 2018.

Ultimately, that's the figure on which Mr Wheeler is judged by the Minister of Finance.

The Governor, whose term expires next year, may need to be Action Man for some time yet.

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