Cablegate: Reserve Bank of New Zealand Sees Recession As a More

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ZNR UUUUU ZZH
R 240207Z JUL 08
FM AMEMBASSY WELLINGTON
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RUEHBY/AMEMBASSY CANBERRA 5220
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UNCLAS WELLINGTON 000230

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STATE FOR EAP/ANP, EB, INR, STATE PASS TO USTR, PACOM FOR
J01E/J2/J233/J5/SJFHQ

E.O. 12958: N/A
TAGS: ECON EFIN ETRD PGOV PREL NZ
SUBJECT: RESERVE BANK OF NEW ZEALAND SEES RECESSION AS A MORE
IMMEDIATE THREAT TO NEW ZEALND ECONOMY THAN INFLATION.

REF: WELLINGTON 225

1. The Reserve Bank of New Zealand (RBNZ) announced today that it
is cutting the Official Cash Rate (OCR) by 25 basis points. Fearing
that recession pressures pose a greater threat than inflation to the
New Zealand economy in the near term, the RBNZ Governor Alan Bollard
decided to reduce the OCR rate by 25 basis points to the new rate of
8 percent. This is the first time since 2003 that the RBNZ has
reduced the rate. While the majority of local economist were
predicting that Bollard would first wait to see the wage/price data
in August and then announce the change in September, Bollard said,
"more unpleasant international news has emerged sine June and there
is a risk that the domestic economy will slow further" (see reftel).
He predicted that the annual inflation rate (CPI) would peak at
around 5 percent in September then return to a level within the
target inflation band (1 to 3 percent) in the medium term. RBNZ
expects economic activity to remain weak for the rest of this year
and will pick up only gradually next year aided by high export
prices, tax cuts and higher government spending. In the meantime,
the RBNZ will keep a close eye on pressure on wage/price demands and
the rate of decline in the value of the Kiwi dollar in calculating
further adjustments to the OCR.

Is the Rate Change a Mandate Change?
------------------------------------

2. (SBU) The decision today by the RBNZ signals a move away from
its original legislated mandate to set the OCR to restrain inflation
between a narrow range of 1 to 3 percent. Bollard has essentially
exceeded the Reserve Bank's legal mandate by this decision. The law
requires the Bank to focus on one responsibility only: keeping the
inflation rate in a band between 1 and 3 percent. Analysts here
have bemoaned in recent months that the Bank does not have the
flexibility to consider the broader impact of interest rates on the
economy and labor market, as the Federal Reserve in the U.S. does.
It appears that Bollard has exceeded his mandate, covering his
tracks by predicting that inflation will fall later this year
despite the Bank reducing the OCR now.

3. Fearing a looming recession the Associate Finance Minister
Trevor Mallard signaled earlier this month that the government might
be considering a possible break with the Bank's 20 year-old legal
mandate by proposing a shift away from interest rates as the sole
weapon against inflation. National Party finance spokesman Bill
English reiterated that his party continues to back the current
framework; saying softening the inflation target would ultimately
lead to even higher interest rates in the long run. In June English
said that, if National won the election, it would not rewrite the
policy target agreements.

4. Foreign Minister Winston Peters argued earlier this month the
RBNZ law might provide some unexpected flexibility in the Bank's
mandate by highlighting a section in the Reserve Bank's statement of
intent that said the Bank aimed to deepen its understanding of
"options for alternative instruments". Mr. Peters said he was
encouraged by the Bank's statement, but feared 95,000 jobs would be
lost unless RBNZ acted soon. "We advocate a rewrite of the act to
enable the governor to take into account the balance of payments,
exports, GDP growth and full employment when setting the official
cash rate." The Finance and Expenditure committee has been
investigating options and is expected to report back to Parliament
in September but is considered unlikely to reach a consensus on
possible immediate changes. Meanwhile today's decision by the RBNZ
may signal a de facto change.

MCCORMICK

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