Bond strength shows heat on Wheeler

All the major banks are now picking Reserve Bank governor Graeme Wheeler will have to go further than Thursday's expected official cash rate cut of 0.25 per cent, to 2 per cent. Photo / Mark Mitchell

We might not trouble the top of the Olympic medal table but when it comes to bond yields New Zealand is leading the pack.

That league table puts us ahead of Australia, the US, Canada, Britain and the rest of the developed world.

It is one of the reasons our dollar remains high and illustrates the pressure our Reserve Bank faces to cut rates, even though that risks fuelling the already hot housing market.

All the major banks are now picking Reserve Bank governor Graeme Wheeler will have to go further than Thursday's expected official cash rate cut of 0.25 per cent, to 2 per cent.

Yesterday BNZ economist Stephen Toplis upped the ante, saying he had now pencilled in cuts next week plus in September and November.

That would take our official cash rate to 1.5 per cent and bring us into line with Australia at least.

A cut this week is now fully priced in by markets which means Wheeler won't exert much downward pressure on the dollar, or retail lending rates, unless he delivers a strong inclination to cut further.

Toplis acknowledges the risk of fuelling the housing market but says lower than expected inflation for the second quarter and the recent surge in the kiwi dollar leave no choice "if the RBNZ remains fully committed to pushing CPI inflation higher".

The second-quarter inflation figure - of 0.4 per cent for the year - was bad enough but "the king hit" would be in the third quarter when, thanks to the latest slump in petrol prices, inflation would be "miles lower" than the Reserve Bank's June forecast.

Yesterday ANZ economists pointed out that market pricing is now weighted to an outside chance of a 0.5 per cent cut on Thursday - a double blow.

"We struggle to see the the rationale for a larger move when the economy is performing well," they wrote.

ANZ's Cameron Bagrie and Philip Borkin take a slightly less bearish view than BNZ's Toplis.

But in their Economic Overview report they highlight New Zealand's place at the top of the bond yield league table as one of the many problems facing the Reserve Bank.

The US has put plans to lift rates on hold, Australia and Britain are cutting again. New Zealand continues to look like a good, stable, high-yielding place. Our Reserve Bank "cannot swim against the tide of global forces", the ANZ team concludes.

Through "ultra-stimulatory policies, central banks are continuing to create market distortions and inflate global asset prices well beyond logical valuations. Yet at the same time they are struggling to generate better growth and inflation outcomes".

"We can't see how delivering further stimulus on top of what has already been seen is actually going to change that picture."