By Roger J Kerr
The RBNZ were cajoled (or bullied?) recently into reversing their previous stance of not cutting the OCR through April to June.
Could they now be convinced that as global FX markets have conspired against them at the wrong time with a weaker US dollar, they should not muck about and just slash the OCR by 0.50% to 1.75% on 11 August?
The money markets are already pricing-in two 0.25% cuts to the OCR by November, so why wait?
To make more of a splash on currency markets to drive the Kiwi dollar lower, a surprise is required that the markets are not expecting.
A 0.50% reduction in one fell swoop would do the trick to really get the NZ dollar down and inflation back above the 1.00% minimum level sooner.
Worries that OCR decreases will just fuel the housing market even more with lower mortgage lending interest rates are arguably not justified as the banks will not necessarily pass-through the full OCR reductions for two very good reasons:-
- Retail deposit rates being paid by the banks (70% of the banks’ cost of funds) are not being reduced as they attempt to hold retail money in their coffers that is otherwise being withdrawn in favour of higher yielding dividend shares or illiquid property syndicated investments.
- The credit spreads (borrowing margins) the banks are now paying on their wholesale debt issues continue to increase with investors around the world demanding higher margins to compensate for the ever decreasing underlying market interest rate. The Aussie-owned banks being on credit watch negative by the rating agencies due to Australia’s sovereign rating being reviewed does not help the banks’ borrowing margins.
Should the Reserve Bank of Australia move to cut their OCR again this week to a new low of 1.50%, the pressure will be intensified on the RBNZ to reduce the gap between the NZ and Australian interest rates, so as to relieve the upward pressure on the NZD/AUD cross-rate (currently back up to 0.9470).
The RBNZ slashed the OCR aggressively at this time 12 months ago when international dairy prices plummeted. The financial situation in the dairy industry is more acute today and the RBNZ highlighted the seriousness of the financial stresses at their recent special economic update.
Financial risks from trading existing assets (i.e. housing market) is not as direct and hard-hitting as financial risks from less cash income and falling asset values (i.e. the dairy industry). The RBNZ have belatedly recognised that the balance between to two has to be weighted more towards the productive heartland of the NZ economy.
Whilst very low interest rates do distort some economic and investment decisions in New Zealand, the benefits in terms of commencing major infrastructure build projects (transport, irrigation and civil) earlier than normal due to the massive reduction in the financing costs are massive. It is an opportunity in a lifetime for central government, local government and the private sector to advance such projects at a pace.
Roger J Kerr contracts to PwC in the treasury advisory area. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com