KEY POINTS:
It is always somewhat unnerving when the Reserve Bank resorts to drastic action. A minor tweak here and there is its normal mode of operation. It is even more discomforting when a monetary policy statement from the Governor differs greatly from that uttered only three months previously. It is little wonder, therefore, that last Thursday's statement from Dr Alan Bollard has attracted much debate and no little teeth-gnashing.
The governor pulled no punches in forecasting tough times for householders. Growth of just 0.9 per cent in the year to March 2009, unemployment surging to 6 per cent by 2011, an inflation rate of 4.7 per cent by September and a 13 per cent slump in house prices in the 18 months starting last November were among the pot-pourri of bad tidings. The prognosis was much worse than in the central bank's March statement and considerably more pessimistic than Treasury predictions in the May 22 Budget.
Clearly, this reflects Dr Bollard's increasing unease about the reverberations from the credit crunch in the United States and the pace of the economic slowdown. That view was first voiced, albeit in a coded manner, in the second week of April, when he appealed to banks and businesses not to hibernate in the face of tighter credit markets and talk of tough times. His concern can only have been increased subsequently by the likes of declining business and consumer confidence, tumbling retail sales and further rises in the price of fuel and food.
Dr Bollard's response last week was anything but timid. On Thursday, while he left the official cash rate unchanged at 8.25 per cent, he signalled a start to its easing cycle in September, a year earlier than he had predicted in March. Another cut in December was on the cards, he told a parliamentary select committee. Analysts expect the official cash rate to be around 7 per cent by this time next year.
To put Dr Bollard's words in context, it is useful to hark back to the view of economists immediately after the Budget. Almost as one, they said the inflationary impact of the tax cuts announced by the Finance Minister had put an end to any prospect of interest-rate cuts before the end of this year. On Thursday, Dr Bollard described those cuts as having "a significant but not major effect on inflation in the short term". The extra stimulus was, he said, "relatively minor in the context of the other factors currently affecting the economy". They could even provide "some offset to the many headwinds facing the household sector". Much of the inflation - notably that arising from fuel and food - is imported, and the governor has, therefore, fixed upon the labour market, asking workers not to push up wage demands.
Soon after Dr Bollard's plan to kick-start the economy was announced, banks began to drop some of their rates. The fact that most mortgage debt today is in fixed-rate loans means relief is some way off for many.
But for others, who have watched the brakes being applied by the Reserve Bank for a long spell, lower rates will be extremely good news. The psychological fillip should not be underestimated. Likewise, there was cheer for exporters in the swift decline of the dollar. Sheep and beef farmers, in particular, now stand to reap the benefit of buoyant world prices, even if not to the same extent as their dairying counterparts.
For quite some time, the Reserve Bank has cautioned New Zealanders about the consequences of their spending habits. Dr Bollard may consider Thursday's gloomy statement as the ultimate vindication of those warnings. Some economists say he was being unduly pessimistic. They point to the remarkable resilience of the economy over the past few years. This will be its acid test.
