Bollard cites unpleasant news as he slashes interest rates

-By Jenny Ruth

Thursday 24th July 2008

Bollard cut his official cash rate (OCR) from 8.25%, where it has sat since July last year, to 8%. It's the first time the central banker has cut rates since July 2003.

Financial markets had been pricing in a 50/50 chance of a rate cut, just as economists rated it a very close call, and reacted sharply. The currency dropped more than half a US cent to 74.45 cents within 15 minutes of the announcement and the March 2009 90-day bank bill futures fell 0.23 percentage points.

"As the statement says, we've seen quite a marked downturn in the domestic economy and the news from offshore has been increasingly bleak in the last six weeks" (since Bollard's last monetary policy statement), says Darren Gibbs, an economist at Deutsche Bank.

"On top of that we've got all the credit concerns, highlighted last night with Hanover (suspending repayments to investors)," Gibbs says.

Craig Ebert, an economist at Bank of New Zealand, says while the decision to cut or not today was "a line ball call," what was surprising is that Bollard has signalled further cuts.

Bollard said: "Provided that the outlook for inflation continues to improve and there is no excessive exchange rate depreciation, we would expect to lower the OCR further."

Ebert says Bollard has "more or less egged things on" and encouraged the market to start pricing in even more OCR cuts.

Because the pressures on bank funding costs have been upwards, the OCR cut may be inconsequential for retail interest rates, but if the wholesale market gets carried away, banks may be able to lower their mortgage rates, Ebert says.

However, there is potential for the currency "to front-run this sort of message. The (central) bank did expect the currency to be coming off a bit, but only in a very gradual fashion." If the currency does slump a great deal, that may rule out further OCR cuts. "It's going to be an interesting battle," Ebert says.

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