Faced with a rapidly slowing economy, New Zealand's central bank cut the official interest rate by half a percentage point on Thursday, double the reduction forecast by analysts. A cut in the official cash rate (OCR) of a quarter of a percentage point had been widely expected.
But Reserve Bank of New Zealand governor Alan Bollard went further and cut it to 7.5 percent from 8 percent, pointing to a "marked slowdown" in the local economy, and further deterioration in the outlook for the global economy. "While domestic activity is likely to pick up late this year as a result of personal tax cuts ... we expect a prolonged period of household sector adjustment and below-average growth," Bollard said.
"The weakness in economic activity is expected to translate into lower inflation pressures in the medium term. Headline inflation is expected to peak around 5.0 percent in the current September quarter before trending down thereafter."
When the central bank cut the OCR by a quarter percentage point to 8.0 percent in July - the first cut in five years - Bollard said then that further reductions were likely.
With the surprise half a percentage point cut Thursday he raised expectations of a further significant cut next month. Deutsche Bank said Bollard was easing rates aggressively despite high near-term inflation, while ASB bank said the focus was on the interest rates paid by households and businesses, which the central bank wants to see lower. ASB expected the rate to be lowered to 6.5 percent "sooner rather than later".
"We put a 60 percent probability of another 50 basis point cut in October as we are putting weight on the governor wanting to keep driving effective lending rates down," the bank said. Bank of New Zealand economist Stephen Toplis, who admitted to being "gobsmacked" by the size of the latest cut, said the market had a further 50 basis points of cuts priced in before year's end.
In his statement Thursday, Bollard said that with medium term inflation pressures expected to ease, it was appropriate to move towards a less restrictive monetary policy stance. "Looking ahead, the scale and timing of further official cash rate reductions will depend on signs of declining inflation pressures and on exchange rate adjustments."
Bollard said that while the household sector was mainly leading the marked slowdown in the New Zealand economy, the business sector was coming under pressure from both rising costs and falling demand. A Reserve Bank statement said activity in the New Zealand economy was likely to have contracted in each of the first three quarters of 2008, and was expected to fall by a total of 0.8 percent over that nine month period. The New Zealand dollar dropped half a US cent immediately after the central bank announcement to trade around 65.65 US cents.