Reserve Bank surprises with 25bps rate cut

10.30am - By SIMON LOUISSON

Reserve Bank Governor Alan Bollard shrugged off his nick-name as "Dr No Change" when he announced a surprise cut in the Official Cash Rate (OCR) today.

The 25 basis point cut to 5.50 per cent is the first OCR rate move in nearly a year and the first since Dr Bollard's appointment in September.

He said the bank did not have a more pessimistic view of the economy than previously, but dry conditions, potential electricity shortages and the Sars virus added "downside risks to the economic outlook".

"At this stage we do not expect a large enduring economic impact," Dr Bollard added.

Economists had expected the bank to wait until its full monetary and economic conditions review on June 5, but Dr Bollard said there was sufficient evidence of economic slowdown both domestically and internationally to act now.

"The available data suggest that growth in the New Zealand economy is slowing as we projected in our March Monetary Policy Statement.

"A weak international economy is now being reflected in softer activity in New Zealand's tradable sector."

The New Zealand dollar edged down to US55.73c on the news, from US55.90c in early trading, while 90-day bills -- from which banks fund their mortgages -- dropped sharply to 5.62 per cent from 5.79 per cent at yesterday's local close.

The local currency has risen sharply this year as investors cashed in on the relatively high yields of New Zealand assets compared with other major economies.

Dr Bollard noted that he had made the cut despite the domestic economy being relatively robust, especially in the housing sector.

Real Estate Institute figures out yesterday showed the national median house price in March was a record US$200,000 -- up 7.5 per cent on a year ago. Prices in the all important Auckland market were up 6.5 per cent for the year while in the hot Nelson-Marlborough market, prices were up over a third.

Today's move will give that market fresh impetus as banks are almost certain to follow with mortgage rate cuts.

The continued strength of the New Zealand dollar will help lean against inflation and Dr Bollard said the change to the Policy Target Agreement signed with Finance Minister Michael Cullen on his appointment had allowed him to act now.

The agreement mandated the bank to avoid "unnecessary instability in output, interest rates and the exchange rate".

"Based on this, we have been prepared to adjust interest rates a little faster in response to the unfolding evidence of a slowdown," Dr Bollard said.

He added the bank's usual warning that future cuts would depend on evidence that inflation would settle comfortably within the 1-3 per cent target range "over the medium term".

The bank foreshadowed rate cuts in January when it said that if the exchange rate appreciated further there could be scope to cut rates.

"In our judgement, these conditions have now been met," Dr Bollard said.

Commercial bank economists expect at least two more rate cuts of similar magnitude later this year. Today's cut is only a surprise in that it brings forward the time-frame and could let Dr Bollard off being criticised for acting too slowly.

Dr Bollard said the bank was now more confident that inflationary pressures would ease, "which is the basis of today's decision".

"This should not be interpreted as the bank now having a more pessimistic view of the New Zealand economy, but rather as a consequence of our earlier expectations being confirmed."

The New Zealand dollar fell steeply in response to the announcement. It dropped more than half a US cent from US55.90c just before the announcement to US55.30c. It also lost heavily against the Australian dollar where the cross rate fell to A89.65c from A90.37c at yesterday's close.

Ninety day bank bill yields also fell, dropping to 5.61 per cent from 5.79 per cent at yesterday's close.

"The kiwi is obviously hurting. This obviously came as a surprise to the market," said one Wellington bank dealer.

She said the kiwi had lost some of its immediate attraction on the basis of its higher interest rates, but she predicted the fall would be limited.

"If it you look at it from a relative perspective against the likes of the euro or US dollar, the yield differential is still very substantial. Short-term, the easing is going to be an obstacle for the kiwi against the US dollar but once players look at the yield differential, there will still be good support."

Jason Wong, economist at First NZ Capital said the data coming out over the last few months had been supportive of easier monetary policy.

"I think everyone basically knew there was an easing in the pipeline, it was just a case of exactly when and the Reserve Bank's come to the party."

UBS Warburg chief economist Robin Clements said he was unsure if the easing was justified.

"The risks recently in regard to trading partner growth, Sars, drought have all been pointing in this direction, but it is a bit more forward looking than we'd anticipated.

"I still think the basic parameters of what we're going through will be a fairly modest easing cycle."

- additional reporting by REUTERS


RBNZ: March 2003 Monetary Policy Statement