Cash rate cut not justified, says bank

Reserve Bank Governor Alan Bollard Photo / Mark Mitchell

The Reserve Bank of New Zealand cannot justify cutting interest rates in this Thursday's monetary policy statement, as inflation is already too high and the Christchurch earthquake rebuild will stoke it further once it gets under way next year, says the local arm of Hong Kong Shanghai Banking Corporation.

The first bank to come out against a rate cut, HSBC says the February 22 quake has delayed New Zealand's economic recovery but that the Official Cash Rate is the wrong tool to assist its reignition.

"The economy is supported by the automatic fiscal response via the Earthquake Commission, and also the jobs initiative announced, and more fiscal spending coming in the likely Budget," HSBC chief economist for Australia and New Zealand, Paul Bloxham, says in a commentary published today.

"The OCR is the wrong tool to respond to the quake, especially when inflation is rising.
It's better to keep rates lower for longer."

However, the HSBC view is at odds with expectations from Westpac, ANZ New Zealand, the Bank of New Zealand and ASB, all of whom are forecasting a rate cut of up to 50 basis points from the current 3.0 per cent to 2.5 per cent, to add stimulus and underpin shaky business sentiment since the quake.

And Moody's Analytics also believes a rate cut is justified because simply keeping rates on hold "won't be enough to kick-start the recovery in the wake of February's devastating earthquake," says Sydney-based Moody's associate economist Katrina Ell. Moody's Analytics is a unit of Moody's, which owns global rating agency Moody's Investors Service.

"Commercial banks need to see a concrete commitment by the central bank to maintain stimulatory policy settings before mortgage rates will be lowered substantially," she says, with only a rate cut giving confidence for banks to pass on official benchmark interest rate cuts to customers.

A rate cut now would also have a faster-than-usual impact on economic conditions, as around half of all home mortgages are now loaned at floating interest rates, after a big shift away from fixed rates over the last year as interest rates began falling.

However, HSBC's Blosham says the Canterbury rural economy has not been badly affected by the latest earthquake. While the city of Christchurch accounts for around 6 per cent of total economic activity, "the government has the capacity to provide a timely and targeted fiscal package, in addition that automatically provided by the EQC."

With the rural economy performing well, the exchange rate falling, and global inflation pressures rising, New Zealand "could see higher domestic inflation at a time when headline inflation is well above the RBNZ's comfort zone due to tax changes."

Prime Minister John Key's two sets of comments welcoming the prospect of a rate cut "will not sway the staunchly independent RBNZ," HSBC says, acknowledging this week's OCR decision is "more finely balanced than usual."

"Of course, anything could happen. There is a tangible risk that the RBNZ does follow market expectations and cuts rates 25 basis points.

But we think it may instead use the tactic employed during the global financial crisis and say rates are to stay low until recovery is entrenched."