Glass half-full for Reserve Bank

Alan Bollard says the Reserve Bank would want to see real reasons to go below 2 per cent. Photo / Mark Mitchell

Reserve Bank Governor Alan Bollard indicated clearly yesterday that he is nearing the end of this easing cycle.

How much lower he cuts the official cash rate from the 3 per cent it now sits at will depend partly on how the economy responds to the hefty doses of stimulus that have already been dispensed, and partly on whether the bank is right to plump for the less grim of two possible views of how the international economy will play out.

Yesterday's 50 basis point cut was at the light-footed end of market expectations, in contrast to previous cuts which gave the market all it was expecting and then some.

And the bank's projection of 90-day wholesale rates bottoming out at 3 per cent later this year shows it sees a trough of 2.5 per cent in the OCR, where many in market were looking for 2 per cent - and still are.

But Bollard's comments when appearing before Parliament's finance and expenditure select committee indicated 2 per cent might be his bottom line.

The closer official rates get to zero the less traction they have, given the need for banks to attract funds whether it is from depositors or on overseas wholesale markets.

"We would want to see real reasons to go much below 2 per cent," he said.

Bollard has now cut the OCR by 5.25 percentage points since last July. Much of the effect of that has yet to be felt, the bank argues, because of the popularity of fixed-rate mortgages when rates were rising.

It reckons the average mortgage rate people are paying will fall another 2 points over the next year or two.

That stimulus coincides with a large boost from fiscal policy and the export-buffering effect of a sizeable fall in the exchange rate.

Those three factors, the bank expects, will limit the recession to six successive quarters - that would still make it the longest since the 1970s - and it is predicting a fragile recovery from the second half of this year.

It will build to the point that 4.8 per cent growth is recorded in the year to March 2011.

That forecast has raised some eyebrows but the bank points out that historically the rebound from recessions is often quite swift, but those growth rates do not persist, and that while comparable to what happened after the Asian crisis it would be a gentler rebound than that from the early 1990s recession.

The bank expects New Zealand's trading partners to contract by 2 per cent this year and beyond that the outlook is highly uncertain.

"The [US] Federal Reserve is poised between two views," Bollard told MPs on the select committee.

"One is that the US economy troughs in the middle of this year and the other is no, it is next year." There were also two expert views on how China would fare.

The bank has opted to err on the positive side and assume that the global economy will recover next year.

"If we are wrong we will be too optimistic about domestic growth."

The banks' forecasts also assume a protracted period of rebalancing in the economy away from household consumption and towards business investment and the export sector.

Bollard said consumption would be negative this year and flat next year.

The forecasts in the monetary policy statement show only a feeble recovery thereafter, so that by the end of its projection period (March 2012) consumption would be still below current levels in real per capita terms. The flipside is an improvement in household savings rates.

ANZ National Bank chief economist Cameron Bagrie said that rebalancing needed to happen and would happen. "Consumption as a proportion of GDP has been trending up for 20 years. We need a sustained period when it grows less than GDP."

The further 10 per cent fall in the exchange rate the Reserve Bank is assuming is also part of that rebalancing story, Bagrie says.

But he considers the bank's short-term growth outlook too optimistic. He sees the economy contracting 3 per cent this year, not 1.1 per cent as the Reserve Bank forecasts.

Bank of New Zealand economist Craig Ebert said he would like to believe the recovery would start in the second half of this year. "But we don't think it's likely."

That was as partly because it was based on government spending leading the recovery, but more because the BNZ saw a deeper contraction in business investment than the Reserve Bank did.

GOING DOWN
* Reserve Bank Governor Alan Bollard yesterday cut the Official Cash Rate from 3.5 per cent to 3 per cent.
* Bollard has cut the OCR by 5.25 percentage points since July.
* The Reserve Bank believes the average mortgage rate people are paying will fall another 2 points over the next year or two.