Liam Dann: The case for and against a rate cut

Graeme Wheeler. Photo / Getty Images

Three good reasons to cut the OCR on Thursday ... and three equally valid reasons to keep the status quo.

Like three quick wickets in a test match on an otherwise lifeless pitch, this week's monetary policy statement suddenly has a bit of an edge to it.

Which is to say, Reserve Bank Governor Graeme Wheeler might cut interest rates on Thursday. Or he might not.

Technically this is always the case of course. But suddenly there is some fresh uncertainty about it all.

When the Governor held rates in October it was judged a near certainty that there would be a cut in December.

But while most economists are still leaning towards a cut, market pricing leans towards a hold.

It is a sign the economy is delicately poised. It is unclear whether it improves or deteriorates from here.

Anyway on with the cricketing theme.

Here's a hat-trick of reasons to cut on Thursday and three more not to:

Cut

• Inflation:

Or the lack of it. Inflation targeting remains the primary focus for the Reserve Bank. For decades that focus has been on keeping in down.

But now with commodity prices depressed and internet retailing everything keeps getting cheaper. We're getting dangerously close to the one per cent bottom end of the target range. Some argue there is even a deflation risk.

Westpac and ASB economists are picking that weak inflation will force the bank to cut not just this month but two more times next year taking the official cash rate to 2 per cent.

This seems to be at odds with the way the Reserve Bank sees it. It sees the big deflationary effect of the commodity slump (oil in particular) flowing through the data by March. After that the picture will be clearer. The Bank seems more inclined to take a wait-and-see approach on the issue.

• The weather:

Nothing stuffs the New Zealand economy like a drought and this year's El Nino weather system is expected to bring with it a real humdinger.

A really bad drought can knock as much as full one per cent off New Zealand's GDP growth.

How serious this year's is won't be clear until late summer and autumn but if you believe the meteorologists, then one more rate cut tospeed up the economy makes a lot of sense.

• China:

We know the Chinese economy is slowing and we're already feeling some effects -- most through dairy prices and the knock-on from Australia's commodity pain. Will we get a soft or hard landing from here? Nearly every Western commentator based in China seems certain that the slowdown will be harder than hoped. New Zealand will need to be running lean and mean with a lower dollar to help boost tourism and exports if this is the case. A rate cut will help.

Hold

• The housing bubble:

What's the biggest risk to our economy? Most experts will tell you that it's a property market bubble. We've all got so much tied up in property that a major market slump would be disastrous. The Reserve Bank and the Government have introduced a number of regulations and tax rules to try and calm speculation in the market. Further cuts run counter to that. They only make it even cheaper to borrow and invest -- further fuelling the bubble. On that basis if there is any opportunity to avoid a cut, the Bank may look to take it.

• The economy:

Despite everything it just isn't that bad. Maybe we are just tougher than we realise. Even after the dairy price slump GDP growth has held up at around two per cent. Some economists including the NZ Institute of Economic Research now see growth heading back towards three per cent during 2016 on the back of tourism and migration, which are still going gang busters. If that's where we are heading then it is hard to make the case for taking rates back to the record lows. The last time we cut to 2.5 per cent was as an emergency measure in response to the Christchurch Earthquake.

• The dollar:

The kiwi has already fallen from US88c in mid-2014 to about US66c. That has started to provide our exporters with a tail wind and even if it holds at those levels it will continue to do so as long term hedging rolls off. On top of that we are finally about to see the US Federal Reserve raise rates. that will push the US dollar higher and the kiwi will fall further. This takes the pressure off the Reserve Bank and strengthens the case a hold, wait and see approach.

• Umpire's call

So what should the Governor do? On balance a cut still looks logical to me. I'm inclined to see drought as the big risk we need to be ready for. Let's get some speed up as we head into this long dry summer. There's no inflation risk, there some signs that new regulations may have cooled Auckland housing slightly and at 2.5 per cent there will still be plenty of some room to cut further if the economy goes really pear-shaped.