Shadow board favours OCR cut

Reserve Bank Governor Graeme Wheeler is due to announce whether or not the Reserve Bank will change the Official Cash Rate on Thursday. Photo: Mark Mitchell.

NZIER's monetary policy shadow board favours a cut to the official cash rate of 25 basis points to 3 per cent tomorrow.

But as the next best option there is more support for an on-hold decision than for a cut of 50 basis points.

The shadow board is a panel of nine economists and business leaders the New Zealand Institute of Economic Research asks to distribute 100 points across possible interest rates. It then combines the results to indicate in a probabilistic way what the board considers the OCR should be.

This week's poll found 49 support for 3 per cent, 28 per cent support for no change and 16 per cent support for a 50 basis points cut to 2.75 per cent.

NZIER economists Christina Leung said there had been a considerable shift in favour of rate cuts over the past six weeks, consistent with a weaker economy.

"Business and consumer confidence have dropped to their lowest levels in three years, with the deterioration more marked in dairy-intensive regions rocked by very low dairy prices," she said.

"Headline inflation remains very low at 0.3 percent for the year to June - well below the Reserve Bank's target mid-point of 2 per cent. The inflation outlook is also benign."

But the implications of a sharply lower exchange rate give some of the panel pause.

Motu economist and former Reserve Bank chairman Arthur Grimes favours a cut to 3 per cent.

"The world economy is shakier now than it was six weeks ago, especially China, Australia and Greece, so a further cut in the OCR is warranted. However the lower exchange rate and likely accompanying rise in inflation caution against being too aggressive in cutting rates," he said.

Victoria University economics professor Viv Hall sees upside risks to medium-term inflation in very accommodating financial conditions both globally and in New Zealand.

"And these have recently been joined by material exchange rate depreciations and therefore potential non-temporary tradables inflation increases," he said.

"But domestic demand pressures have begun easing, two-year inflation expectations remain reasonably benign, and key export commodity prices continue to fall, though more modestly in New Zealand dollar terms."

On balance, Hall concludes, there is a case, but not yet a totally compelling one, for a 25 basis point cut now rather than waiting until September.

But the Bank of New Zealand's head of research Stephen Toplis said there were huge risks to the economic and inflation outlook and sees a stronger case for a deeper OCR cut.

"If dairy prices don't recover and drought hits we could be headed for recession and much lower rates. But if the currency keeps falling, much higher headline inflation will pose a significant challenge for the Reserve Bank suggesting significant upside pressure for rates even as the economy softens.