Bank pushes open door to cash rate cut

The Reserve Bank had already signalled the official cash rate would not rise. Photo / Mark Mitchell

OCR remains at 3.5% as guidance inclines towards possible easing.

The Reserve Bank has opened the door to a cut in the official cash rate, but the conditionality attached suggests any decision to go through with it remains some way off.

As expected, the bank left the OCR on hold at 3.5 per cent and moved its forward guidance from the resolutely neutral - could be either up or down - stance in the March review to one with an easing tilt.

It had already prepared the ground. Deputy governor Grant Spencer two weeks ago made it clear using interest rate hikes to curb Auckland's runaway housing market was not an option. And the bank's chief economist, John McDermott, said that "evidence of weakening demand and domestic inflationary pressures would prompt us to consider lowering interest rates".

Parsing yesterday's statement, market economists stress the conditionality and wiggle room of any easing bias: a lower OCR would be appropriate if demand weakened and wage and price-setting outcomes (not just intentions or expectations) settled at (not just headed towards) levels lower than is consistent with the inflation target (leaving open whether that means the 2 per cent mid-point or the full 1 to 3 per cent bandwidth).

Bank of New Zealand economist Stephen Toplis took the word "settle" to indicate that the Reserve Bank would need several observations through time of wage and price-settling behaviour before it responded.

"Consequently any rate cut would be later rather than sooner."

Toplis does expect economic growth to slow, and more than the Reserve Bank anticipates.

"But we think the softening will be accompanied by a weakening in the exchange rate that will offset the disinflationary impact of the slowdown, leaving the Reserve Bank's projected inflation track largely unchanged."

ASB chief economist Nick Tuffley detects a heightened level of nervousness at the central bank about how weak inflation is in traded goods, where prices are influenced by world prices and the exchange rate. He now puts the odds of an OCR cut this year at 50:50, up from 25 per cent.

Tuffley notes that the bank has dropped the reference in its March statement to the New Zealand dollar needing "a substantial downward correction".

It has been replaced by the observation that its appreciation, while key export prices have been falling, is "unwelcome".

That suggested the Reserve Bank was becoming resigned to the New Zealand dollar remaining stronger for longer than it previously anticipated, Tuffley said.

The Kiwi dollar dropped around US1c against the US dollar after the statement and short-term wholesale interest rates also eased as the market moved to price in 33 basis points of cuts to the OCR over the next 12 months.

ANZ chief economist Cameron Bagrie found the market reaction somewhat surprising as there was "not a lot of new information" in yesterday's statement.

The Reserve Bank still expects underlying inflation to pick up, albeit gradually and from low levels.

"Until that expectation changes, there are still a few hurdles to be cleared before cuts are realistic," Bagrie said. "An extended period of stable OCR settings remains our baseline forecast. However, if core inflation remains low ... in combination with an elevated New Zealand dollar, dairy sector challenges and an eventual prudential response to housing, a reassessment of current OCR settings would be warranted."

Westpac chief economist Dominick Stephens believes the most likely scenario is that the OCR will remain on hold for quite some time.

"However, we believe there is roughly a 40 per cent chance of at least two OCR cuts, depending on what happens with inflation expectations," Stephens said.

"If cuts do occur, they will occur very late in the year, because only then can the Reserve Bank verify that inflation expectations have fallen, and only then will the bank have new mortgage restrictions in place to help slow the housing market."