Bollard may be done cutting rates for now as inflation eases

Thursday 11th June 2009

Reserve Bank of New Zealand Governor Alan Bollard may be done cutting interest rates this cycle after predicting a more moderate track for inflation and noting signs that the worst recession in 30 years may be abating.

Bollard held the official cash rate at 2.5%, amid tentative signs of a pick-up in the domestic economy while global economic activity stabilised offered the central bank positive prospects “for the first time in some months.”

Inflation would probably trough at 0.7% in the 12 months through September, the first time it’s fallen below the bank’s target band of 1% to 3% since December 1999.

“We think it is now unlikely that it will cut again in this easing cycle,” said Robin Clements, economist at UBS New Zealand. “The 90-day projections suggest the RBNZ has not built in any such cuts to its own forecasts.”

Bollard’s decision to keep rates unchanged has rattled industry groups such as the New Zealand Manufacturers and Exporters Association, who complained the high kiwi will stymie an export-led recovery.

Bollard said the strong currency adds an “unhelpful tension” to the bank’s projection, but that global events were driving the market, and he was unable to effectively intervene.

The central bank’s latest forecasts are for the 90-day bank bill rate to be little changed from current levels through the first half of 2010 before rising through 2011. The 90-day bills were recently at 2.84% and the central bank is forecasting them to average about 2.8% through the first half of 2010.

Bollard reiterated his expectation that the OCR would remain low until late 2010, and said it could move “modestly lower” in the coming quarter.

The global response to the credit crisis and substantial easing in monetary and fiscal policy had improved financial conditions, but the world wasn’t out of the woods yet, with New Zealand likely to experience negative or weak growth for the next few quarters, he said.

The New Zealand dollar traded at 63.40 U.S. cents, from 62.68 cents immediately before the release. The kiwi has soared 21% from its low in early March. The trade-weighted index jumped to 60.10 from 59.46 before the report.

Bollard embarked on the steepest series of cuts to the OCR in July and has slashed 575 basis points off the benchmark rate as he seeks to revive the nation’s flagging economy, which fell into recession last year. Asian economies, led by China and India, have started to show signs of recovery, and domestic confidence has lifted from its trough.

Signs of a rebound in household spending and residential investment, a pick-up in net immigration, lower taxes and lower interest rates boost confidence New Zealand’s recession is past its trough, Bollard said. He added there is still room for banks to reduce shorter-term lending rates.

Bollard warned the mix of a rapid rebound in consumer spending with a stronger New Zealand dollar would put the sustainability of future growth at risk, and if the currency’s strength lasted too long, it could stifle the forecast recovery in the export sector.

“The fact that the Reserve Bank is expecting inflation to drop below 1% - the decision to do nothing is really hard to understand,” said John Walley, chief executive of NZMEA. “It is no longer acceptable to simply bemoan the volatility of our exchange rate.”

Government figures yesterday showed export prices recorded their biggest slide since 1957 in the first quarter, led by a slump in dairy products, suggesting weaker returns from the nation’s overseas shipments will constrain economic growth this year.

Merchandise export prices fell 8.2% in the first three months of 2009 from the fourth quarter last year, the first decline in about two years, according to Statistics New Zealand. Prices of dairy products tumbled 21%, the biggest quarterly decline since the series began in 1950.

The central bank lifted its projected average for the currency on a trade-weighted basis to 55.9 from 52.6 in its last monetary policy statement in March. It predicts the currency will keep its current strength in coming months, before it resumes a steady depreciation into 2011.

Recent data from Quotable Value, the Real Estate Institute, Barfoot & Thompson, and Harcourts New Zealand have found a pick-up in the property market, as a surge in net migration combined with a fall in new building consents helped housing demand outstrip supply.

Electronic card spending at New Zealand retailers rose last month, according to government figures this week, suggesting lower interest rates and tax cuts have filtered through to consumer spending. Retail transactions on credit and debit cards rose 0.9% in May, the second consecutive monthly increase, according to Statistics New Zealand.

Bollard reiterated his concerns over the lack of movement by banks in passing on cuts to the OCR, and said the increase in funding costs from higher retail deposits didn’t “fully explain the relative lack of movement of interest rates at shorter terms.”

Earlier this week, Parliament’s Finance & Expenditure select committee slammed banks for failing to pass on cuts to the OCR, accusing them of profiteering while they received tax-payer subsidies.

Banks have continued to lift long-term lending rates amid signs the first recession in a decade has begun to abate, despite the Bollard calling them “out of line” with expectations in April.

Westpac Banking Corp. raised its three- and five year rates to 6.95% and 7.9% respectively, while ASB Bank became the first bank to lift its five-year rate to 8% earlier this week. Bank of New Zealand and Australia New Zealand Bank are offering five-year rates at 7.99%, while Kiwibank, National Bank and TSB have increased their rates to 7.95%.

The banks defended the increases, saying they have had to lift the cost of lending as they raise returns on term deposits in a bid to attract offshore funding. Long-term mortgage rates have increased around 150 basis points since early February as increased government debt issuance has raised concerns about inflation when monetary policy begins to tighten.

The economy shrank 0.9% in the first three months of this year, and the central bank predicts it will contract in the second and third quarters this year. The government announced it would run operating deficits for at least the next decade.

The central bank’s outlook for the current account deficit improved from its previous statement as very weak demand for imports helped rebalance the economy. It predicts the deficit will rise to 8.2% of GDP this year, before it shrinks to 6.1% in 2010. In its last forecast it predicted the deficit would rise to 8.4% this year, and remain high at 8.3% next year.

Bollard said demand for workers is now significantly weaker as skilled labour shortages have abated to comparable levels in the in the early 1990s. Unemployment rose to a six-year high 5%, and the Treasury predicts it will rise to 7.5% in the next two years. The RBNZ lifted its projection for the jobless rate to peak next year at 7.1%, up from 6.8% in the previous MPS.

Businesswire.co.nz

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