Editorial: Rate cut risky, but still the right decision

Opinion

At first glance, there was an odd aspect to the Reserve Bank's decision to cut the official cash rate to 3.25 per cent. Would this not simply give more impetus to rapidly rising house prices in Auckland?

Only last month, the central bank's governor, Graeme Wheeler, said this market - the result of cheap money, high immigration and a shortfall in supply - was the biggest risk to the financial system. And yesterday, within minutes of his announcement, the main banks were seeking to entice customers with even cheaper mortgage rates.

That outcome had meant the country's economists were divided before yesterday's move. Some thought the Reserve Bank would act, others believed it would wait until it had seen the effect of measures designed to cool the housing market. These include its own step to make it harder for investors in Auckland to obtain credit, and the Government's tax move targeting speculators.

Mr Wheeler has decided there is no reason to delay. He expects the looming measures to take investors out of the market, and for house-price inflation to be slowed by the building of more new homes and the fading of the immigration boom. More immediately, the Reserve Bank would have derived comfort from the fact that almost 80 per cent of loans are on fixed rates.

House prices were, however, far from the only thing in Mr Wheeler's sights. His primary focus is not the state of the housing market or the rate of economic growth, but consumer price inflation. The cut in the official cash rate was, he said, "appropriate" because of low inflation and an expected weaker demand in the economy.

It is designed to nudge inflation from the current 0.1 per cent to the 2 per cent midway point of the bank's target range by the second half of next year. Without the cut, the weaker prospect for dairy prices and recent rises in petrol prices would slow growth and the return of inflation to its target point.

Central to all this is the Reserve Bank's surprise at the ongoing slump in prices for the country's dairy products. This is more pronounced than expected. The decline in those prices started in February last year, and hopes of a cyclical upswing have been persistently dashed. The resulting spending pinch was felt first in provincial areas and service industries. But the longer dairying's struggle continues, and petrol prices continue to rise, the more it will undermine consumer demand throughout the country.

There are obvious risks to the Reserve Bank's decision. It has limited its scope to reduce rates in response to any international setbacks, including, perhaps most damagingly, a severe slump in the Chinese economy. Its housing prognosis could also come back to bite it, although even in the normal course of events a cooling is surely due.

But Mr Wheeler deserves some credit for seeking to get ahead of the curve. A failure to act would probably have prompted a spike in the already over-valued dollar. And a slight touch on the accelerator now makes more sense than a headlong rush somewhere down the road.