Interest rate cut looks set

By JAMES WEIR - The Dominion Post | Monday, 08 September 2008

The Reserve Bank is expected to cut interest rates to 7.75 percent on Thursday, heading for about 7 percent early next year and close to 6 percent late next year, to help boost a sliding economy.

The economy is in recession, with nine months of slowdown expected, according to some economists. A weak and slow recovery is expected later this year.

Westpac bank economists say the official cash rate will be down to 7 percent by early next year, but that will be much higher than previous troughs because the central bank must still tackle inflation.

Market pricing suggests the official cash rate could reach 6.5 percent or lower later next year. Bank of New Zealand says "we will be lucky if it gets to 6 per cent late next year", compared with the previous low of 4.5 percent.

Two-year fixed-term mortgage rates, now just under 9 percent, may fall below 8.5 per cent by late this year. They could hit the five-year average of 7.8 percent by the middle of next year, "optimistically", BNZ says. Rates would only go much lower if the economy was weaker than expected.

Other economists said this week's 25 basis-point rate cut was fully priced in to mortgage rates already, so fixed-term rates would probably not fall much more unless the Reserve Bank wanted that and cut the cash rate by 50 basis points.

On the way down, the Reserve Bank may pause and hold cash rates about 7 per cent late this year to see what happens, before deciding if it needs to cut more.

The Reserve Bank is counting on a weaker economy to reduce inflation pressures in the next few years, "but they don't have a lot of room for error", Westpac Bank says. Even with a recent fall in oil prices, forecast annual inflation will still be about 5 percent.

A weaker Kiwi dollar, which has dropped about 10 percent against the US currency since July, is offsetting most of the help from a 25 percent drop in world oil prices.

In July, Reserve Bank governor Alan Bollard surprisingly cut the cash rate earlier than expected to 8 per cent. It was the first drop in five years and sparked in part by the worst international financial market crisis since the Great Depression of the 1930s.

The next cut, however, is widely anticipated, with Deutsche Bank expecting another two cuts this year.

The Reserve Bank was expected to cut rates this week, partly because of big cuts to global economic growth forecasts in the past two months. Europe, Britain and Australia look weaker and that has seen a drop in many commodity prices.

Since the July Monetary Policy Statement, New Zealand's economic outlook has worsened, with business and consumer confidence slumping to deep gloom.

On the other hand, petrol prices have dropped from $2.20 a litre back to about $2, leading to a small rebound in confidence, but prices remain high, cutting into household budgets. There will be more relief next month when tax cuts come into force, and lower borrowing costs will help too.

But ASB Bank said the Reserve Bank could tick all the boxes for another rate cut this week.

The slowdown was "well and truly entrenched", the inflation outlook was better and the exchange rate fall was "orderly", ASB said.

There was still concern over the cost of borrowing internationally, but that was not a big enough worry to spark a cut in the cash rate to 7.5 per cent this week.

Small, steady cuts would continue till the cash rate was 6.75 per cent early next year, ASB said, but it would be cautious as inflation remained uncomfortably high.

WHAT'S EXPECTED: Reserve Bank monetary policy statement is on Thursday. Rate may be cut from 8 per cent to 7.75 per cent. Rates are expected to keep falling as economy slows. Two-year fixed-term mortgage rates may be held to about 9 per cent but fall to 8.5 per cent late this year. Official cash rate may fall near to 6 per cent late 2009. Inflation forecasts, at about 5 per cent, remain a concern.