Spain and Greece to weigh on OCR call

A protest against the financial crisis and the latest government measures in Madrid. European uncertainty should keep NZ's Reserve Bank in 'wait and see' mode this week. Photo / AP

The highly uncertain international outlook is expected to keep the Reserve Bank in wait-and-see mode when it reviews the official cash rate on Thursday.

While the weekend's news of the €100 billion ($162 billion) bailout of Spanish banks should reduce angst levels in global financial markets, the Greek elections next weekend could reverse that.

Both money market pricing and the consensus among market economists see only a one-in-six chance of an OCR cut this week from its current 2.5 per cent.

Looking further ahead, their views diverge, however. Most forecasters polled by Reuters expect the Reserve Bank to hold firm until the March quarter next year and for the OCR to be 3 per cent by this time next year.

By contrast as recently as last week the markets were pricing in an OCR of 2.25 if not 2 per cent by then and they still consider it likely that the OCR in a year's time will be lower than it is now.

Since the bank last reviewed the OCR statistical revisions have indicated the New Zealand economy entered this year with less momentum than previously thought.

Export commodity prices have continued to fall, at an accelerating pace, and the Budget has confirmed that fiscal policy will be substantially contractionary.

Even with a net outflow of migrants, the unemployment rate has risen to 6.7 per cent and employment growth has slowed.

Some of the economic data out of the United States and China has been uninspiring and the Reserve Bank of Australia has judged it necessary to cut its OCR again.

While those factors argue for its New Zealand counterpart to do the same, they have to be weighed against the potential stimulus to come from the rebuilding of Christchurch and signs of life in the housing market.

Retail sales are significantly higher than a year ago and on an upward trend, Bank of New Zealand head of research Stephen Toplis said.

"What is remarkable is that spending has been so strong at a time when the household savings ratio has gone from a low of minus 9.5 per cent back in 2003 to a small positive now. Even if the ratio climbs further the headwinds are unlikely to be as great as has been the case over the last decade."

Crucially, too, monetary conditions have already eased substantially since the April review.

The exchange rate, about which governor Alan Bollard was fretting six weeks ago, has since dropped nearly 6 per cent against the US dollar and 3.6 per cent on a trade-weighted basis.

Wholesale interest rates have also fallen, pushing mortgage rates and deposit interest rates to multi-decade lows.

"The Reserve Bank [has] in the past been reluctant to lower the OCR below 2.5 per cent, with Dr Bollard concerned that exceptionally low interest rates would trigger a renewed credit boom, especially in the housing market, or at least impede the necessary deleveraging of the economy," Deutsche Bank chief economist Darren Gibbs said.

In addition economists believe the central bank would want to keep its powder dry in case rate cuts were needed to bolster confidence in the event the economy is sideswiped by another global shock. Consider the what-ifs, Westpac chief economist Dominick Stephens says.

"What if the eurozone becomes a disaster zone? The Reserve Bank would want to deliver confidence-boosting OCR cuts. But if it reduces the OCR [this] week its latitude to deliver cuts in the worst case scenario would be curtailed. Better to wait," he said.

"What if Europe avoids meltdown? In that scenario the Reserve Bank would be best placed with an OCR of at least 2.5 per cent. After all, confidence in the New Zealand economy is still reasonably strong, and the Reserve Bank is conscious of the risk that the resurgent housing market and post-earthquake construction activity could prompt inflationary pressure."