Moody's Analytics and HSBC make the cases for and against a RBNZ rate cut on Thursday

Here is Moody's Analytics argument for a 50 basis point cut in the Official Cash Rate by the Reserve Bank of New Zealand on Thursday:

With the nation's economy on the brink of slipping back into recession, a promise from the Reserve Bank of New Zealand to hold rates steady for an extended period won't be enough to restore confidence in the wake of February's devastating earthquake. The central bank needs to cut the official cash rate by 50 basis points this week to kick-start activity. February's 6.3 magnitude earthquake, which decimated Christchurch's central business district, has shaken nationwide confidence and flattened the embryonic recovery.

After the prime minister took the extraordinary step of signaling last week that he thought the central bank—which is independent—should cut rates, financial markets are expecting the benchmark rate to be returned to the emergency level that prevailed at the height of the global financial crisis. The sharp decline in implied yields on New Zealand government bonds—a proxy for movements in wholesale funding costs—highlights the dramatic downward revision to future interest rate expectations.

The three-year rate has fallen more than 30 basis points in the past fortnight and is down 70 basis points since mid-November. Markets abandoned expectations for five interest rate increases over the next 12 months as the economic outlook continued to sour. Yet interest rates charged by retail banks on fixed-rate mortgages have barely moved in the past four months. Last week, ANZ and ASB reduced one-year fixed rates by roughly half a percentage point, while the three-year rate has moved down a meager tenth of a percentage point despite the cost of funding falling considerably more.

Commercial banks need to see a concrete commitment by the central bank to maintain stimulatory policy settings before mortgage rates will be lowered substantially. Dovish rhetoric will not be enough; nothing short of a rate cut will provide sufficient confidence to banks for them to pass on the recent decline in wholesale funding costs to customers.

Action by the Reserve Bank would have a corollary benefit of enhancing the monetary policy transmission mechanism. Historically, the majority of Kiwi households have opted for fixed-rate mortgages, meaning changes in the cash rate take considerably longer to flow through to home loan rates and stimulate the economy. Since September, however, more than half of all new mortgages have been on floating rates.

A rate cut now would provide a powerful incentive for more prospective borrowers to opt for the currently considerably lower variable-rate mortgage, a shift that would make monetary policy a more potent tool for managing the macroeconomy.

Here's HSBC's view and argument against a rate cut:

The earthquake that struck Canterbury on 22 February has resulted in significant damage to the capital stock. Estimates suggest NZD10bn worth of damage to buildings and infrastructure. Economic activity for February and March has also been reduced in the Canterbury region as a result. Reconstruction, which was already slow to begin after the 4 September quake, will now be delayed further. Combining these, we expect GDP to be 0.9pp lower in H1, with growth picking up in H2 and boosted in 2012 by reconstruction.

In our view, the case for an OCR cut is not clear. A fiscal policy response is more appropriate. The quake did not damage the financial or payments system and there are mechanisms in place to deliver disaster relief. About 6% of the economy has been severely affected and the government has the capacity to provide a timely and targeted fiscal package, in addition to that automatically provided via the Earthquake Commission.

Broader conditions were also improving prior to the quake. Recent business surveys suggest a pick-up driven by the export sector and rising commodity prices. Fonterra boosted payouts to milk farmers by 60c, equivalent to NZD1.4bn (0.7% of GDP) in February. Globally inflation is building, oil prices rising, and a rate-cut driven NZD depreciation could see higher domestic inflation at a time when headline inflation is well above the RBNZ’s comfort zone due to tax changes.

Last week’s call from Prime Minister Key for rate cuts will not sway the staunchly independent RBNZ. The RBNZ’s Policy Target’s Agreement explicitly mandates looking through the effects of natural disasters. Recent cuts to banks’ fixed mortgage rates are also unlikely to reflect ‘whispers’ from the RBNZ, as some commentators have suggested.

Of course anything could happen. There is a tangible risk that the RBNZ does follow market expectations and cuts rates 25bp. But we think it may instead use the tactic employed during the GFC and say that rates are to stay low until recovery is entrenched.