Analysts divided on how low Bollard's rate cut should go

Reserve Bank Governor Alan Bollard

Reserve Bank Governor Alan Bollard is expected to cut the official cash rate again on Thursday and to reinforce the message that he expects rates to stay low for an extended period.

Economists and the financial markets are in two minds, however, about whether he will cut the OCR, currently 3 per cent, by 25 or 50 basis points.

Those in the 50-point camp, which includes the major New Zealand-based banks, point to three things in particular.

First is what businesses were saying in the Institute of Economic Research's quarterly survey of business opinion. It indicated the March quarter was every bit as bad as the December quarter, when the economy shrank 0.9 per cent, and called into question the Reserve Bank's forecasts of recovery in the second half of this year.

Second is the fact that, despite talk of green shoots, forecasts for the world economy this year keep getting revised lower, most recently by the International Monetary Fund.

This month's international survey by Consensus Forecasts found economists' expectations for our trading partners in 2009 slashed to a contraction of 2.2 per cent, weaker than the 1.8 per cent the bank assumed in its March statement.

Third is the fact that monetary conditions - specifically the exchange rate and longer-term interest rates - have tightened since the bank's March statement, the opposite of what it wanted and expected. Longer-term wholesale interest rates have risen about 80 basis points since then, resulting in sharp increases in some mortgage rates.

This prompted an unusual, and ineffectual, statement from the Governor on April 1 that the rise in longer-term interest rates was "unwarranted and inconsistent with the monetary policy outlook". He reminded the market that the bank's March statement projected interest rates to remain "at relatively low levels for an extended period".

Advocates of a smaller cut in the OCR, or none at all, like Deutsche Bank chief economist Darren Gibbs, stress the need for monetary policy to focus on the medium term, not the unambiguously grim short-term outlook.

World financial markets have rallied in recent weeks. "Whilst this could yet prove a bear market rally, we have to respect the price action at this point," he said.

A more optimistic, or at least less pessimistic, outlook had also been reflected in strengthening commodity prices, including those of some New Zealand exports, and in the currencies of countries, including New Zealand, seen as better placed to benefit in the event of a pick-up in global growth, Gibbs said.

He also cites signs of improvement in the housing market and is unconvinced by the view that housing has had its day as the investment vehicle of choice. "Whilst tighter lending conditions and concerns about job security will mean the purchase of a home will remain off the radar for many, the sheer attractiveness [of] current mortgage rates means the recent pick-up in housing market activity is likely to be sustained."

That is also a tactical consideration for the Reserve Bank, Gibbs argues: the lower longer-term rates are, the greater the risk of a repeat of the last tightening cycle when the bank's OCR increases gained little traction in the mortgage belt because of the prevalence of longer-term fixed-rate loans.

ASB chief economist Nick Tuffley acknowledges tentative signs that the housing market is starting to stabilise.

"But the recovery in confidence is fragile," he said. A lesson from the past was that if policymakers removed monetary and fiscal stimuli too early they risked stamping out a fragile recovery.

"The Reserve Bank is running out of OCR ammunition - we agree there is little point in cutting the OCR below 2 per cent. But that is no reason to go easy on rate cuts now, just in case tomorrow turns out worse than expected," Tuffley said.