End to easing - for now

The dollar rallied after Graeme Wheeler's announcement. Photo / Mark Mitchell

OCR cut to 2.5% signals a likely end to the current cycle.

The Reserve Bank has cut its official cash rate by a quarter of a percentage point to 2.5 per cent, signalling a likely end to the current easing cycle.

At 2.5 per cent, the rate has revisited levels seen at the time of the global financial crisis and Christchurch quake, so economists said conditions would need to get much worse for the bank to drop it more.

Even at its new level, New Zealand rates remain substantially higher than most western countries' central bank benchmarks, making it an attractive prospect for overseas investors chasing yield.

Much to the bank's likely annoyance, the Kiwi dollar rallied by US1c to US67.40c after the announcement.

Video: Reserve Bank Cuts OCR to 2.5pc:

"At 2.5 per cent, and with the prospect of that remaining stable, it was a very attractive proposition," said ANZ Bank senior foreign exchange strategist Sam Tuck.

Deutsche Bank NZ chief economist Darren Gibbs said cutting the rate further, back to GFC/earthquake levels, was likely to form a "psychological barrier" for the central bank.

"Things would have to deteriorate markedly to get the bank to move rates further down," Gibbs said. "In the end it's going to come down to the economic data ... here and beyond."

The Reserve Bank highlighted the current El Nino weather pattern, and the chance of drought, and low dairy prices as likely risks to the economy.

The kiwi had risen since August, partly reversing the depreciation that occurred from April. Reserve Bank governor Graeme Wheeler said the rise in the exchange rate was "unhelpful", adding that "further depreciation would be appropriate".

Gibbs said: "In the near term, it is drought-watch and currency-watch because those two things combined are the most likely to push the bank to ease again."

In forecasts with its rate review, the Reserve Bank said the forecast 90-day bill rate track - which the market takes as a guide for the future direction of the OCR - was 2.6 per cent by the third quarter of 2016, staying at that level through 2018.

The bank said the NZ economy had softened over 2015, due mainly to lower terms of trade. Combined with rises in the labour supply from strong net immigration, the slowdown has seen an increase in spare capacity and unemployment, it said.

House price inflation in Auckland remained high, posing a financial stability risk, but there were early signs that might be moderating.

Consumer price inflation was below the bank's 1 to 3 per cent target range, mainly due to the kiwi's earlier strength and the 65 per cent fall in world oil prices since mid-2014.

The Reserve Bank said the inflation rate was expected to move inside the target range from early 2016.

"Monetary policy needs to be accommodative to help ensure that future average inflation settles near the middle of the target range," it said.

UBS economist Robin Clements said the bank had toned down its easing bias. "We believe this is the final cut this cycle, albeit the door is ajar to further easing."

Most economists had expected the bank to cut its rate and for 2.5 per cent to be the bottom, but that view was not universal.

Westpac has been an outlier but it was sticking to its guns. "Our view is that economic activity, house prices and inflation will be subdued enough over coming months to prompt further official cash rate cuts next year."

Westpac expected the rate to fall to 2 per cent in 2016. ASB also expected the rate to fall to 2 per cent next year, with the first cut in June.

El Nino could weaken GDP

Atmospheric measures indicate strong El Nino conditions this summer that could reduce New Zealand's gross domestic product by 0.3 per cent-to-0.8 per cent, says a Reserve Bank paper.

The bank said there were a number of risks and uncertainties to its outlook, including whether the current El Nino results in drought conditions and weaker output. However, given the range of conditions in an El Nino, it didn't assume a drought in its current projection.

El Nino is a climate cycle in the Pacific Ocean which has a global impact on weather patterns.

The likely impact on the New Zealand economy was considered in a separate research paper put out by the central bank, by Dean Ford and Amy Wood.

It said the volatile Southern Oscillation Index, which measures the stage and intensity of the atmospheric cycle, is currently almost two standard deviations below its mean, suggesting strong El Nino conditions are present.

According to the National Institute of Water and Atmospheric Research, this El Nino could rank among the four strongest such events ever recorded.

The research paper says the 1997/98 El Nino, which had a similar Southern Oscillation Index reading to the current one, significantly affected New Zealand. The subsequent contraction in agriculture and primary food manufacturing alone shaved 0.7 percentage points from GDP in the March quarter of 1997 to the September quarter of 1998.

The Reserve Bank says the actual impact of the current El Nino will depend heavily on where drought occurs.

- NZHerald, BusinessDesk