RBNZ could cut OCR to new record low as souring dairy eats into growth

Reserve Bank governor Graeme Wheeler could lower the official cash rate to as low as 2.5 per cent by October analysts say. Photo / Thinkstock

The Reserve Bank of New Zealand may take interest rates to a new record low as dairy prices, the currency and the labour market weigh on economic growth.

Westpac Bank's chief economist Dominick Stephens is now forecasting the cash rate to be 2 per cent by December, with four 25 basis point cuts from next week.

"We now expect the RBNZ to reduce the OCR to 2.0 per cent by the end of this year," wrote after today's round of grim economic news. "This will involve one reduction of 50bp - most likely in September, but possibly as early as next week's July OCR Review. At the other three meetings, we would expect 25bp reductions in the OCR."

Meanwhile, AMP Capital Investors New Zealand chief economist Bevan Graham won't rule out the central bank lowering the official cash rate below 2.5 per cent, and expects governor Graeme Wheeler will return the cash rate to that level by October.

"The setting of monetary policy has been pretty challenging in the last couple of years, we've had this environment where growth has been accelerating, but inflation has been falling," Graham told media at the fund manager's quarterly briefing in Wellington," Graham said.

"We're now going into an environment where we're we are going to see growth coming off, but inflation probably moving higher."

He said inflation is set to rise due to a lower exchange rate, and cuts to the benchmark rate will depend on whether the central bank looks through currency-related effects to core inflationary pressure.

Any further reductions below 2.5 per cent will be driven by how much further dairy prices slump, whether the currency gains, and wage growth, he said.

"It's going to be data dependent, and largely dependent on three things - obviously the exchange rate where that goes from here," Graham said.

"Where dairy prices go from here, as I say this is a cyclical move at some point they're going to go up, we just don't know how much lower they're going to go in the interim. The other one is still wages, capacity utilisation measures are going to be important in this as well."

Between March and July last year the RBNZ's Wheeler hiked rates 100 basis points from a record low to 3.5 per cent, making New Zealand one of the first developed countries to lift interest rates since the global financial crisis in 2008, when credit markets collapsed.

Since September the central bank's tightening bias has been on hold, and last month it cut rates by 25 basis points, taking it to 3.25 per cent, while signalling further cuts could come.

Traders are pricing in a 100 per cent chance Wheeler will lower the key rate next week, and have priced in 61 basis points of cuts over the coming 12 months, according to the Overnight Index Swap curve.

While it was possible rates may go lower than the 2.5 per cent record low, Keith Poore, AMP Capital's head of investment strategy, thought it unlikely the central bank would rush any move.

"If they'd learnt anything from last year it's not to go too far too fast in one direction, that's a big lesson," Poore said.

Overnight prices for whole milk powder, the country's key commodity export, dropped more than expected in the GlobalDairyTrade auction, sending the kiwi dollar to a fresh five-year-low.

Dairy prices have remained lower for longer amid higher global supplies in New Zealand, Europe and the US, weak demand in China and an import ban in Russia.

The weaker prices come as New Zealand production is rising heading into the country's peak supply period in October, raising concern about the impact on the nation's economy.

On the back of extended weakness in dairy prices, AMP Capital slashed its expectation for gross domestic product growth to 2.3 per cent in 2015, from 3.2 per cent annual growth it expected in its April quarterly briefing.

Looking ahead, it expects 2016 growth to be 2.2 per cent, revised down from 3.1 per cent, followed by 1.9 per cent growth in 2017, down from an expected 2.7 per cent.

"At this point it seems pretty prudent to expect growth is going to be lower on the back of that because it appears that (dairy) prices are going to be lower for longer," AMP Capital's Graham said.

"We're not expecting growth to be collapsing it's not all bad news, while dairy prices are weak, meat are prices are doing okay, especially beef, wool prices are okay, we've had a pretty meaningful adjustment in the exchange rate, so it's a bit of a boost to the broader export sector.

"Rather than solid GDP growth we were talking about last time, now we should call it healthy, rather than anything more robust," he said.