Opinion: OCR to trough at 2% for some time from mid 2009
29th Jan 09, 12:50pm
By BNZ Markets Head of Research Stephen Toplis The RBNZ has slashed the Overnight Cash Rate a further 150 basis points. That's a massive 400 basis points in just three meetings. We were a little surprised by the magnitude of today's move. We'd thought that a more conservative 100 points might do the trick. Having said this, we have no difficulty with the rationale that the RBNZ has provided to support its move. In short, it's terrified by what it sees happening offshore and the likely implications of that on the New Zealand economy, so it's taken a no-holds barred approach. With this in mind, we have sharply revised lower our future track for the New Zealand cash rate. The RBNZ seems, for good reason, fixated on international developments. In our opinion, these will continue to surprise on the downside. This being so, from a consistency perspective, the Bank will have no option but to push rates much lower yet. Consequently, we now believe the Bank will lower rates a further 75 basis points at its next meeting. This is a big move but smaller than the 100 the market is currently pricing and still consistent with the RBNZ's stated view that "any further reductions will be significantly smaller than those seen recently." The "significantly" was dropped in by Dr Bollard at his press conference and is not in the published statement. It would then be very unlikely in our mind that a central bank would stop immediately after a series of cuts of this magnitude without slowly deflating the easing process. Moreover, it will be difficult to stop easing as a swathe of very poor economic data is produced locally. Headlining this will be a sharp rise in unemployment. So we have then built in further cuts of 50 basis points and 25 points at the following two meetings respectively. Put all this together and the cash rate troughs at 2.0%, where it should stay for some time. We see this very much as a central forecast with risks on both sides. It is plausible that further deterioration in economic activity sees an even more dramatic fall. In contrast, the RBNZ will be reluctant to push rates so low that conventional monetary policy no longer remains an option in the way that the United States is currently afflicted. Generally, we are very concerned that too much weight is currently being put on the power of interest rates to "fix" things. In normal times lower interest rates provide householders with more spare cash to go out and spend and, in turn, stimulate the broader economy. At the same time investment activity is promoted. However, in the current climate one can't help but think that any cash relief is more likely to be saved by householders and businesses alike. This means that the impact of falling interest rates will be substantially dampened. As a result, just pushing rates forever lower may be an inappropriate course of action. In fact, it may prove counter productive as folk dependant on income from investment for their livelihood have their earnings slashed. These are the very same folk who have seen their capital bases also blasted by the collapse in global asset prices. As the clamour for the banking sector to cut rates in line with the cash rate grows louder, spare some time for those for whom falling interest rates is an unmitigated disaster. Alas, from here on in the outlook for the New Zealand economy is very poor indeed. We have weathered reasonably well stage one of the recession but stage two, the wash from the global rout, is only just hitting us. We have recently lowered our already miserable growth forecasts for calendar 2010 to -0.9%. The risks to this remain to the downside. This is much worse than the +0.3% we expect for 2008. As recently as last month Governor Bollard declared that the recession was over; it seems he has now reached a somewhat different conclusion, as have we all. While this remains so, the only direction for interest rates, and probably the NZD, is down. It's not when, it's how much. * All of the research produced by the BNZ Markets team of economists is available here.