RBNZ cuts rates as export prices slump

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By Leith van Onselen

The Reserve Bank of New Zealand (RBNZ) has surprised the market this morning by cutting the official cash rate by 0.25% to 3.25% – the first reduction in more than four years.

According to the release accompanying the cut, RBNZ governor, Graeme Wheeler, slated the blame primarily on falling export (dairy) prices, which have fallen sharply and will reduce national income and slow demand:

The New Zealand economy is growing at an annual rate around three percent, supported by low interest rates, high net migration and construction activity, and the decline in fuel prices. However, the fall in export commodity prices that began in mid-2014 is proving more pronounced. The weaker prospects for dairy prices and the recent rises in petrol prices will slow income and demand growth and increase the risk that the return of inflation to the mid-point would be delayed.

However, Wheeler also blamed the stubbornly high New Zealand dollar:

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With the fall in commodity prices and the expected weakening in demand, the exchange rate has declined from its recent peak in April, but remains overvalued. A further significant downward adjustment is justified. In light of the forecast deterioration in the current account balance, such an exchange rate adjustment is needed to put New Zealand’s net external position on a more sustainable path.

One factor working against the cut is New Zealand’s red hot housing market, particularly in Auckland. However, the RBNZ seems satisfied that the upcoming additional macro-prudential curbs on investor lending will moderate any upside risk to prices from falling mortgage rates:

House prices in Auckland continue to increase rapidly, and increased supply is needed to address this. The proposed LVR measures and the Government’s tax initiatives planned for 1 October 2015 should ease the impact of investor activity.

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The RBNZ also flagged that further cuts may be in the pipeline, given the expected weakening of demand as national income falls:

A reduction in the OCR is appropriate given low inflationary pressures and the expected weakening in demand, and to ensure that medium term inflation converges towards the middle of the target range.

We expect further easing may be appropriate. This will depend on the emerging data.

The 90-day interest rate forecast reinforced this view, reducing by 56bp at the March 2017 point to 3.11% (from 3.67%. Prior to the announcement, the swap market had its track at 3.50% at the March 2017 point.

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Market reactions to the cut were also emphatic, with the NZD/USD plunging from 0.7200 to 0.7019.

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About the author
Leith van Onselen is Chief Economist at the MB Fund and MB Super. He is also a co-founder of MacroBusiness. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.