Economy Hub: Rate cut - new mood or bluff?

Wheeler’s surprise move at odds with the way he was talking a few weeks ago.

Has Reserve Bank Governor Graeme Wheeler seen the light on deflation risk? Or has he bluffed the market to get maximum bang for his buck with this latest rate cut?

For someone who had indicated a reluctance to cut as recently as a speech in Christchurch on February 3, he certainly made a big splash yesterday - surprising markets and pushing the dollar down sharply.

Global market conditions have deteriorated further and locally concern about the dairy industry slump has skyrocketed.

Perhaps most significantly, the Reserve Bank's own quarterly survey of expectations in mid-February showed predictions for inflation over the next two years plunging to a 22-year low.

But there may be a mischievous element to yesterday's move. The power of monetary policy has been waning as rates around the world near zero and Wheeler needs to ensure his cuts drive the dollar down and shift market expectations.

The New Zealand dollar obliged yesterday, falling after Wheeler surprised the financial markets.

The kiwi fell to US66.30c as at 5pm yesterday from US67.78c immediately before the release and US67.26c on Wednesday.

"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," said BNZ Head of Research Stephen Toplis.

ASB chief economist Nick Tuffley was also unimpressed, awarding Wheeler a "brickbat for the extent of the u-turn".

"Back then [February 3] the Governor essentially implied that people forecasting OCR cuts were responding mechanistically to low headline inflation," Tuffley said. "The tone of that speech suggested the RBNZ was a long way from contemplating an OCR cut, and will have contributed to the extent of market surprise."

But he described yesterday's cut as prudent.

The move was also applauded by business groups and will no doubt please the Government, which is seeking to stimulate the economy through the dairy-driven slowdown.

Yesterday's cut increased the chance we could see rates go below 2 per cent for the first time, said Paul Dales, chief economist at Capital Economist in Sydney.

Most major banks are now picking one more cut this year.

Dales was one of the few economists talking up the prospect of a cut in his preview last week. He now says "there is a real possibility" we will see rates below 2 per cent.

"The RBNZ has clearly been spooked by the recent weakening in the outlook for the global economy, the strengthening in the New Zealand dollar and the fall in domestic inflation expectations," he said.

Globally there are growing concerns that Japan-style deflation might take hold in Western economies.

Wheeler stopped short of using the "D word" yesterday but his statement acknowledged the decline in inflation expectations and highlighted the risk that it could become self-fulfilling, driving inflation down further.

Further easing might be required to ensure inflation moved back towards the Reserve Bank target of 2 per cent, he said.

"Monetary policy will continue to be accommodative."

- Additional reporting BusinessDesk

What the cut could mean

Going down

The Reserve Bank surprised markets by cutting 25 basis points from the Official Cash Rate, taking it to a new record low of 2.25 per cent.

Governor Graeme Wheeler cited deterioration in the global growth outlook, dairy challenges and persistent low inflation as reasons for the cut.

He said cheap fuel and other imports continued to keep inflation low and he didn't expect inflation to reach the targeted mid-point of 2 per cent until March 2018.

But he said the domestic economy was still well supported by immigration, tourism and construction activity.

Will your mortgage payments fall further?

Don't count on any more big drops, bank economists say. Some floating rates moved down yesterday but the cost of borrowing in international markets has risen in recent weeks.

That means we're unlikely to see fixed rates fall much further. Some banks will use the OCR cut as an opportunity to get publicity with a special low rate but, longer term, a lower OCR is needed just to keep mortgage rates from rising.

The upside for many homeowners is that yesterday's cut allows those on fixed rates more time to lock in the best deals. So this cut will still assist borrowers and stimulate the economy. It may also still provide fresh impetus for Auckland's slowing housing market - a side effect the Reserve Bank does not want to see.