Liam Dann: Why interest rates will be cut next week

Reserve Bank Governor Graeme Wheeler. Photo / File

The Reserve Bank will cut rates to a record low of two per cent next week but this will have little impact on the economy unless the decision comes with a strong signal that the Bank is prepared to go further, says ASB chief economist Nick Tuffley.

The Reserve Bank has little choice but to cut rates in next Thursday's Monetary Policy Statement, despite the risk of further fuelling the housing market.

That's because inflation has remained persistently low - at an annual rate of 0.4 per cent compared to the target of two per cent.

The New Zealand dollar has stayed stubbornly high, reflecting that fact that despite our rates being at record lows they are still among the highest in the Western world.

But a single cut of 0.25 per cent won't be enough to move the market which has already priced in next week's move, Tuffley said.

So don't expect to see your mortgage rate fall in a hurry.

Bank borrowing costs were also rising because they were having to seek capital offshore to cover the rapid rise in borrowing that was accompanying house price growth, Tuffley said.

"Because local credit growth has accelerated strongly deposit growth was no longer strong enough to cover lending."

Cuts would have to go further now to have any affect.

"What we really want to see from the Reserve Bank is interest rate forecasts that point to a further cut,"Tuffley said.

If that message wasn't clear then we ran the risk of what we saw this week with the Reserve Bank of Australia this week, which was that currency actually rose after a cut.

"So that messaging and a clear indication that more cuts are coming is going to be a big part of it."

Reports from ASB, Westpac economists pick that there will need to be a second cut in the November rate review for the Reserve Bank to achieve any kind of upward momentum on inflation and to put downward pressure on the dollar.

Sydney based Capital Economics goes further suggesting that "to address the issue of persistently low underlying inflation we think that the RBNZ will have no choice but to cut interest rates to 1.50 per cent,or lower, next year."

What we really want to see from the Reserve Bank is interest rate forecasts that point to a further cut.

The Reserve Bank has consistently expressed concern about the financial stability risk of the soaring Auckland housing market.

This may have underpinned some reluctance to cut rates harder in the past.

The introduction of new lending restrictions - was expected to generate a short pause on housing market growth and would buy the Reserve Bank a window of about six months to cut rates and focus on the inflation side of the equation, Tuffley said.