Calls to rethink bank's rate cuts

Reserve Bank Governor Graeme Wheeler. Photo / Mark Mitchell

Ahead of likely moves by Graeme Wheeler to lower OCR, financial experts question overall inflation strategy.

Economists expect the Reserve Bank to cut its official cash rate by 25 basis points to 2.5 per cent at this Thursday's monetary policy statement, but the financial markets are not so sure.

The central bank, at its official cash rate review on October 29, hinted heavily that another rate cut was in store and most economists expect it to move at this Thursday's monetary policy statement. The Reserve Bank aims to contain annual inflation within a 1 to 3 per cent range, but the consumers price index has been well below the bottom end of the band for the last year or so.

In its last comment, the Reserve Bank said that to ensure future average CPI inflation settles near the middle of the target range, some further reduction in the official cash rate was likely.

But doubts have emerged of the ability of central banks to influence inflation through interest rates, which is why the markets are less than convinced that a cut will eventuate this week. "There is a growing realisation that lowering interest rates may not have much of an impact on getting inflation up anyway, and it has been notable that the Reserve Bank of Australia in recent weeks has taken that line quite strongly," said Stephen Toplis, Bank of NZ head of research.

"There is no doubt in my mind that it is very difficult to get inflation higher anywhere in the world at the moment. That's been a problem from the Reserve Bank given that it is in their PTA (policy targets agreement).

"I personally think that it is time for a bit of a re-think, where we can accept lower inflation for longer, provided the economy is doing all right."

There is little evidence of inflation in the economy. The NZ dollar has remained firm and wage inflation is running well below the Reserve Bank's expectations with the supply of labour - largely led by migration - exceeding demand.

Furthermore, dairy prices have remained weak, and oil prices have not improved as the Reserve Bank might have expected. However, the Reserve Bank will be wary of the effects that lower interest rates will have on the property market.

"Not for the first time, we find ourselves torn between what we think the Reserve Bank should do and what we think it will do," Toplis said.

"We still do not believe there is enough to gain from lowering interest rates to compensate for the potential costs of doing so."

Deutsche Bank NZ economist Darren Gibbs said the strong Kiwi dollar, together with weakening global commodity prices, suggested there were large downside risks to the Reserve Bank's previous inflation forecast.

"It's time the Reserve Bank took a more active approach in trying to make absolutely sure that the economy does get back up to above-trend growth, and that we do see a turnaround in unemployment."

Close call

• Economists expect the Reserve Bank to cut its official cash rate by 25 basis points to 2.5 per cent.
• Market pricing suggests rate cut will be more of a 50/50 call.
• Doubts as to whether low interest rates can influence inflation.
• Unemployment at 6 per cent, low dairy prices, back case for a cut.