NZPA
Interest rate cuts will be slow to filter through
Thursday July 24, 05:12 PM
A five-year wait for the Reserve Bank to cut interest rates ended today but it may take until well into next year before the benefits filter through.
Bank governor Alan Bollard sprang something of a surprise when he cut the Official Cash Rate (OCR) to 8 percent from 8.25 percent.
He signalled last month he would cut in September but economists said he went earlier due to escalating concern of deepening recession.
Despite expectations inflation will top 5 percent this quarter, he signalled a series of cuts. Economists predict the OCR will be down to 7.25 percent by Christmas.
But don't expect Christmas presents from your bank. They have been stretched by the global credit crisis and are paying more overseas to raise funds to on-lend.
Even state-owned Kiwibank, which funds onshore and has made the big banks play catch-up, said it will not cut further for now.
It said when it cut rates this month to under 9 percent, it had essentially anticipated the Reserve Bank's move today.
BNZ chief economist Tony Alexander said the benefits of easing monetary policy were going to be very slow to appear for borrowers.
"Running on the assumption that the effects of this (credit) crisis will only slowly disappear over the next two years, for every 0.5 percent cut in the Reserve Bank's official cash rate there might be less than half that of actual reductions in customer interest rates over the coming 12 months.
"So there will not be a repeat of what we saw in 1998 when floating mortgage rates went from 11.25 percent to 6.5 percent.
Even by 2010 floating and fixed rates may still be up at 7.5 percent.
However, others cheered today's news.
The sharemarket, which has lost a quarter of its value since October, rallied 2 percent with some export stocks up 5 percent as the New Zealand dollar fell over one US cent.
Accounting firm Grant Thornton predicted the cut "could be the start of good news" for New Zealand's many privately owned businesses, many of which are financed by home mortgages.
Spokesman Peter Sherwin said the cut could have a double effect.
"There is not only the potential benefit of a reduced cost of borrowings for private businesses, but lowering the OCR also sends a positive signal to business owners which could bolster confidence levels in what has become a turbulent marketplace."
The Manufacturers and Exporters Association said the cut would provide much-needed relief for exporters, but a lower dollar would be double-edged sword, as import prices would rise.
"We are almost seeing a repeat of the conditions in the '70s and '80s where cost increases, rather than increasing demand, pushed inflation upwards," chief executive John Walley said.
He called for an urgent review of the Reserve Bank Act "to deal with the new inflationary landscape".
Westpac chief economist Brendan O'Donovan said Dr Bollard "had taken some pretty big, brave pills to be cutting interest rates before headline inflation has peaked and before he has any evidence that core domestic-related inflation is going to be coming off".
The cut indicated Dr Bollard was "worried like hell about the domestic economy", he told Radio New Zealand.
Goldman Sachs JB Were analyst Marcus Curley said today could mark a turning point for the beleaguered sharemarket.
"It's a pretty important day. Clearly, the Reserve Bank is recognising that it needs to get in behind GDP growth for New Zealand.
"With that philosophy, we can probably take some comfort in saying economic growth should bottom at some stage next year."
Dr Bollard said he acted because more "unpleasant" news had emerged overseas since June.
He cited the rising cost of funds raised abroad by banks as a reason he was able to cut.
"Today's cut will help to mitigate the effect of these increases on the actual borrowing costs paid by firms and households."
Dr Bollard, who refused to answer questions, issued a veiled threat to halt his easing cycle if businesses and workers attempted to gain full compensation for rising oil and food prices.
The weaker economy would make it more difficult for firms to pass on costs and for higher wage claims to be agreed, and that would help bring inflation into line, he said.
Economic activity was likely to remain weak for the rest of 2008 with the weak housing market and high oil limiting household spending and constraining the extent of recovery, he added.
Source: NZPA
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