terminal cash rate now forecast at 2.5%

RBNZ delivered "only" 50bp cut to OCR; terminal cash rate now forecast at 2.5%

The RBNZ today cut the official cash rate (OCR) 50bp to 3.0% (J.P.Morgan -100bp, consensus -50bp). In our view, the RBNZ’s job is not yet done, but future rate cuts will be much smaller than those recently delivered. We look for back-to-back 25bp rate cuts from the next two policy decisions, which will take the OCR down to our revised expected terminal rate of 2.5%. Previously, we expected the easing cycle to end at 2.0%.

There are three key factors explaining the RBNZ’s decision to lower the OCR “only” 50bp today; the significant amount of stimulus already in the pipeline, the expectation that market lending rates will fall, and the need to maintain competitiveness in capital markets. Firstly, the RBNZ highlighted the significant amount of stimulus already delivered. The OCR has been lowered 525bp since July and interest rates are now at “very stimulatory levels.” Fiscal policy responses also have been substantial. Secondly, the RBNZ believes lending rates will fall, with the effective mortgage rate forecast to shed at least 200bp over the next couple of years. Though most Kiwi mortgages are on fixed rates, there recently has been an increase in the number of floating fate mortgages, according to the RBNZ. Thirdly, the Bank is wary that New Zealand needs to retain its competitiveness in capital markets, protecting capital flows given the dire state of its external account.

The statement accompanying the decision to cut the cash rate also offered a lot of doom and gloom. It highlighted that the global economy had deteriorated rapidly, there had been extreme volatility in financial markets, and the “adverse economic forces generated by the crisis would remain dominant throughout 2009.” Since the last RBNZ decision six weeks ago, the news from offshore has been uniformly bad, particularly from the nation’s major trading partners. The dismal domestic situation was also discussed, with the Bank acknowledging that export revenues were drying up and consumer spending remained weak.

As expected, the March Monetary Policy Statement included significant downward revisions to the RBNZ’s economic and financial forecasts. These downward revisions, in our view, were substantial enough to have warranted a 100bp cut to the OCR today. In the year ending March 2009, the RBNZ forecast GDP to contract 2.2% (down from -0.3%) and in the year ending March 2010 forecast GDP growth of 2.7% (compared to 3.2% previously). Both downgrades were mainly owing to sharply lower exports.

Following the RBA’s decision to hold fire on rates last week, leaving the cash rate unchanged at 3.25% on Tuesday, market pricing shifted toward a smaller move from the RBNZ. We, though, believed a 100bp cut to the OCR was still warranted given that, unlike Australia, the New Zealand economy has been in a homegrown recession since the beginning of 2008, one now amplified by international troubles. Australia has only recorded one quarter of negative GDP “growth” so far, but on our forecasts, New Zealand’s recession will extend for at least six straight quarters. Moreover, given easing inflationary pressures, sagging domestic house prices, and a falling terms of trade, the RBNZ had ample scope to ease policy assertively.

ENDS

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