Next rate cut won't be the deepest

Alan Bollard

Economists are confident the Reserve Bank will cut the official cash rate on Thursday but much less sure about by how much.

In the latest Reuters survey eight of the 14 forecaster polled plumped for a 50 basis point cut which would reduce the OCR to 3 per cent and bringing the cumulative easing since last July to 5.25 percentage points.

But they also see a decent chance of cuts of 75 or 100 basis points. Governor Alan Bollard has tended to go further and faster than market economists expected in this easing cycle.

Money market pricing, as reflected in Credit Suisse's swaps-based indicator, is equidistant between 50 and 75 basis points.

As for how low the OCR might go, nine of the forecasters in the Reuters poll see a 2.5 per cent trough by mid-year, four see it falling to 2 per cent and one 3 per cent. But Bank of New Zealand chief economist Tony Alexander sounds a cautionary note: "With huge uncertainty continuing about the global economy, one must also recognise huge uncertainty with regard to exactly when and where interest rates bottom out this year."

Like most indicators, consensus forecasts for growth among New Zealand's trading partners have fallen off a cliff. Last month's survey of economists in those markets found they are expected to contract by a weighted average of 0.9 per cent this year, a stark contrast to the 2.5 per cent growth forecast as recently as September.

"The largest downgrades were for Australia and Asia which until recently were seen as the last bastions of resistance against the global downturn," said Westpac chief economist Brendan O'Donovan.

"We estimate these latest downgrades alone would lower the Reserve Bank's interest rate projections by another 50 basis points relative to what they had in mind in January."

On the home front, surveys of business sentiment have been weak. Key indicators such as firms' expectations of their own activity and their employment and investment intentions are at or near all-time lows.

And that is despite a weaker dollar and hefty doses of fiscal and monetary stimulus already dispensed.

The flipside is a steep fall in inflation expectations, always a central consideration for an inflation-targeting central bank.

"Some would argue that the Reserve Bank has anticipated the global weakness and plenty of stimulus is working its way through the pipeline," said ASB chief economist Nick Tuffley.

"It's a valid argument. However, when facing the largest global downturn since the 1930s Depression, the path of least regret is surely to err on the side of cutting too much than cutting too little.

"Overly loose monetary conditions can be wound back without much consequence."

Tuffley favours a 100-point cut this week and a 2 per cent end-point. But Deutsche Bank chief economist Darren Gibbs said Bollard should cut 50 points and then pause.

The easing of both monetary and fiscal policy already undertaken has been huge and so fast that there has been no opportunity yet to gauge the economy's likely response, he argues.

The central bank and the markets need to distinguish the inevitably poor data which reflect a dire near-term outlook, to which policymakers have already responded, from data which convey new information about the medium-term outlook, he says.

The Reserve Bank of Australia left its OCR on hold at 3.25 per cent last week and if its counterpart here cuts it will mean that, most unusually, the policy interest rate is lower on this side of the Tasman.

However economists point to several reasons why it should be lower.

Recession has come later to Australia. It has only just recorded its first quarter of falling GDP - nine months behind New Zealand.

Monetary policy works faster in Australia, where most mortgage debt is at floating rates.

In addition, said Goldman Sachs JBWere economist Shamubeel Eaqub, New Zealand is more exposed to the global economy, with exports one-third of GDP compared with one-fifth in Australia. It managed to avoid recession at the time of the Asian crisis.

Tuffley argues that Australia has more room to move on fiscal policy, leaving monetary policy with more of the stimulatory load.

"Although New Zealand's government debt position is at a healthy starting point, Australia's is better."

MAN WITH KNIFE

* Alan Bollard is expected to cut the OCR by at least 50 basis points to 3 per cent on Thursday.
* He is headed to 2 or 2.5 per cent by mid-year.
* Last month he cut by 150 basis points