OCR reduced to 3%

By Paul McBeth

Thursday 12th March 2009

Reserve Bank of New Zealand Governor Alan Bollard cut the official cash rate by 50 basis points to a record low 3% saying the ongoing volatility of global financial markets continued to weigh on the domestic economy, which likely fell into a "deeper and more prolonged recession".

"The impact of difficult trading conditions is showing through clearly in reduced export revenues, weak business sentiment, and sharply curtailed investment and employment," Bollard said in Wellington today. He doesn't expect rates to reach the near-zero policy seen in other countries, but didn't rule out further, smaller cuts to the OCR not rule out future cuts, which will probably be much smaller.

Interest rates have been slashed by 5.25 percentage points since July, as Bollard bet inflation will evaporate as the economy stays mired in a prolonged recession. Today's cut matched the median estimate in a Reuters survey. Inflation is forecast to fall to an annual rate of 3.1% in the March quarter, before sliding to a 1.9% annual rate in June, back within the central bank's target band. Inflation was 3.4% in 2008.

The economy contracted 0.8% in the fourth quarter, and will likely extend its slump with a further 0.8% decline in the first three months of this year, Bollard forecast today. New Zealand is stuck in its first recession in a decade as unemployment rises, corporate earnings decline, and overseas demand for the nation's goods dwindles.

GDP shrank 0.4% in the third quarter, following decreases of 0.3% and 0.2% in the March and June 2008 quarters respectively, according to government figures.

The easing of monetary policy, combined with the fiscal stimulus from the government and the rapid depreciation of the currency "will act to the support the New Zealand economy" which is projected to stop shrinking from the second half of the year, Bollard said. He expects New Zealand "to perform better through this period than many of our trading partners" due to the strong position of New Zealand's banking sector, falling exchange rate, and early response to the global economic slump.

The sharp depreciation in the dollar will probably continue through until the middle of next year, with "heightened risk aversion" likely to push it lower in the near-term, the central bank forecast. The weaker currency is expected to lift exports, which are predicted to continue tumbling throughout the year.

New Zealand's dollar jumped to 51.03 US cents from 50.54 cents immediately before the statement. The currency has declined 35% in the past 12 months against the US dollar as the global economic crisis as the central bank slashed interest rates eroding the yield appeal of riskier assets like the kiwi.

"The big debate now is not so much about inflation but over economic growth, and how much more it will suffer," said Craig Ebert, an economist at Bank of New Zealand, in a statement before the announcement. "The big question is how much more OCR easing this justifies."

Slumping global demand has slashed earnings for New Zealand companies and dimmed the outlook for 2009. The nation's largest construction company, Fletcher Building Ltd., posted a 27% slump in first-half profit to $172 million, while second-quarter earnings at Telecom Corp., the biggest company on the NZX50 index, tumbled 92% to $14 million.

Some economists predict the unemployment rate will rise to above 7% this year from 4.6% currently, which is its highest level since 2002. "We expect to see sizeable reductions in employment and investment in the coming year," Bollard said. The central bank forecasts the jobless rate will rise to 5.2% this year, before peaking at 6.8% early next year.

Domestic spending on credit and debit cards, excluding fuel and auto-related outlets, fell 0.4% in February, while fourth-quarter retail sales slid 0.6%, according to government figures.

New Zealand consumer confidence tumbled last month, with Roy Morgan Research's latest poll showing 63% of consumers expect the economy to deteriorate over the next 12 months, up from 60% in early February.

The price of raw materials sank for its seventh straight month, in a sign that weakening world growth is eroding demand for the nation's exports. The ANZ Commodity Price Index fell 4.6% in February, following a 4.3% drop in the previous month.

Rising unemployment and falling corporate earnings has eroded government tax revenue, which was a lower-than-forecast $30.5 billion in the seven months to January 31. Treasury last month said the economy probably extended its recession into a fifth quarter.

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