Bollard spells out cash rate plan

Alan Bollard says the Reserve Bank was unnerved by the unjustified euphoria sweeping through the housing market a month ago. Photo / Mark Mitchell

Reserve Bank Governor Alan Bollard's statement yesterday was as clear - and as dovish - as it could be.

He cut the official cash rate from 3 to 2.5 per cent and left the door open for further easing.

And, crucially, he added an explicit and quantified explanation of what he meant a month ago when he said he expected interest rates to remain low for an extended period.

How low is low? "At or below the current level [2.5 per cent]." And how long is an extended period? "'Until the latter part of 2010." No ifs, no buts, no maybes.

It was a timely reminder, said ANZ economist Khoon Goh, "that the New Zealand dollar is not a one-way ticket higher and equally a signal to borrowers not to panic".

Bollard's statement is heavy with warnings not to get over-excited about "tentative signs of stabilisation" in global financial markets. The timing and extent of a global economic recovery remain highly uncertain, he said.

The New Zealand economy, while in better shape than some, remains weak. The Reserve Bank expects house prices on average to keep falling this year, unemployment to still be rising next year and household consumption to be flat. Business sentiment, notwithstanding the uptick in the National Bank's latest survey, remains low and investment has been cut back.

In these circumstances the Reserve Bank was "a little scared a month ago that there was a sudden euphoria sweeping through the housing market in a way that might lead people to think happy days are here again and plough back in as if nothing had changed," he said.

"That's not the situation."

ASB chief economist Nick Tuffley said the message for borrowers was that there is no real hurry to fix mortgage rates, especially since the door on very low long-term rates slammed firmly shut a month ago.

"The choice of fixing versus floating will remain a trade-off between the certainty of fixed rates and the low debt-servicing costs in the immediate future of floating rates. The Reserve Bank has today given a little more certainty over how long the benefits of floating rate debt will be sustained."

Wholesale interest rates and the dollar fell in response to the statement. The market is now pricing in another cut in the OCR of 25 basis points and that it will stay at 2.25 per cent for another year anyway.

Goldman Sachs economist Bernard Doyle said the governor's statement about how long he expects rates to remain this low should weigh on the New Zealand dollar and reduce the risk that the "carry trade" will drive it higher.

"You certainly don't invest in New Zealand dollars, if you're an offshore investor, for a good night's sleep. You invest for the excess returns you think you can get from taking on additional risk," he said.

"I simply don't believe there is going to be massive demand for our currency in a world where assets are getting pretty cheap and things look like they might be turning."

The fundamental argument that New Zealand needs a long period of a low currency to sort out its structural assets was valid and Bollard was reminding people of that, he said.

By saying he "expects" the OCR to remain at or below 2.5 per cent until the later part of next year, given that it would then take about a year and a half for monetary policy tightening to have its desired effect on inflation, Bollard is in effect saying he does expect inflation to be a problem for the next three years.

Westpac chief economist Brendan O'Donovan has no problem with that. With unemployment climbing and industrial production plummeting, so much slack is building up in the global economy that inflation is a pretty distant prospect.

But he said two of the factors which had helped insulate the New Zealand economy from the worst of the global recession - a weaker currency and the fact that monetary policy was flowing through to lower mortgage rates - had gone into reverse in March.

O'Donovan said Bollard's statement a month ago that that was unwarranted, which he had followed through on yesterday, was entirely appropriate.