Opinion: Why the RBNZ is likely to cut OCR to 5.5%

By BNZ Currency Strategist Danica Hampton NZD/USD stabilised last night and has spent most of the past 24 hours within a 0.6200-0.6400 range. After the carnage seen on Monday, where the melt-down in the financial sector and global growth fears saw NZD/USD plunge from above 0.6600 to 0.6170 "“ its lowest level since August 2006, some consolidation in the NZD/USD was expected. Yesterday's RBA interest rate cut of 100bps raises the risk of the RBNZ taking aggressive action at its next meeting on October 23. Our economists are rating the odds of a 75bps cut as 50:50 and say a 100bps shouldn't be completely ruled out.

While central banks shouldn't make knee-jerk decisions based on fluctuations in financial markets, the increased risks to global growth, escalating cost of funding and yesterday's relatively soft NZIER quarterly survey of business opinion leaves us more convinced than ever that the OCR is headed for 5.50% - lower than the RBNZ and market have assumed. Overnight, government and regulatory bodies around the world stepped up efforts to shore-up confidence in the banking sector. The Fed created a special fund to buy commercial paper, the BBC reports the UK government is poised to announce a comprehensive bank rescue plan and EU finance ministers are still trying to work something out. However, market participants are worried the efforts won't be sufficient to stave off a global recession. While the FTSE closed flat, the DAX fell 1.12% and the S&P500 is currently down 4.2%. Given the speed and magnitude of the recent descent in NZD/USD, we look for consolidation today. A variety of local exporters and real-money accounts have shown appetite for NZD/USD on dips towards 0.6200 and solid support is seen ahead of 0.6170. However, against a backdrop of slowing global growth and fragile risk appetite, bounces should be limited. Initial resistance is seen around the 0.6440 region (ahead of 0.6480-90). Currency markets stabilised a bit last night as governments and regulatory bodies around the world stepped up efforts to shore up confidence in the banking system. The Fed created a special fund to buy short-term commercial paper in an effort to support the financing needs of companies. The fund will be financed at the targeted federal funds rate and will purchase 3-month CP from eligible borrowers. The FOMC minutes highlighted the downside risks to US growth and Fed Chairman Bernanke said "the outlook for inflation looks better", which hints the Fed may be open to cutting interest rates again. Finance Ministers from the European Union have agreed to double the minimum level of guarantees on bank depositions, but are yet to come up with a co-ordinated plan to help the ailing European banking sector. ECB President Trichet has stressed the need for an "international" solution but also notes there are limits on what can be done. Spain announced it was establishing a EUR30b fund to buy troubled Spanish assets and France said it was guaranteeing all bank deposits. The BBC reports the UK government is poised to announce details of a comprehensive rescue package for the banking system. It will likely include capital injections and standby facilities to ensure banks have enough liquidity. Iceland is in all kinds of strife. The Icelandic government took over its second largest bank, propped up its currency and sought a EUR4b loan from Russia in order to stave off national bankruptcy. US equities markets initially bounced after the Fed announced its new commercial paper fund. However, the optimism was short-lived. Lingering concern about the health of the financial sector and worries about a global recession soon took a toll. The FTSE closed flat, the DAX slipped 1.12% and the S&P500 is currently down 4.2%. After the speed and magnitude of the slide in EUR/USD and JPY crosses on Monday, some consolidation looked due. EUR/USD rebounded from yesterday morning's low of 1.3444 to above 1.3700 and USD/JPY stabilised within a 101.50-103.50 range. However, we're far from out of the woods and any restoration of investor confidence will take time. Meanwhile, fears about a global slow-down should continue to underpin USD and JPY.   * Danica Hampton is BNZ's Currency Strategist. All of the research produced by the BNZ Markets team of economists is available here.