Interest rate cuts loom after Reserve Bank changes tack

Reserve Bank Governor Adrian Orr. Photo / File

Economists are factoring in a cut in the official cash rate this year, possibly as early as May, after the Reserve Bank suddenly changed tack to reflect what it sees as a weaker global economic outlook and reduced momentum domestically.

The central bank kept its official cash rate (OCR) on hold at the historic low point of 1.75 per cent, as expected, but the real surprise came in its change of messaging.

At the last OCR review in February, the bank said the next move could be up or down.

But today, the bank said: "Given the weaker global economic outlook and reduced momentum in domestic spending, the more likely direction of our next OCR move is down."

ASB chief economist Nick Tuffley said the bank's next move could be as early as May.

KiwiBank went one better, saying there was a 60 per cent chance of a cut in May, with another follow-up cut to just 1.25 per cent in either August or November.

The New Zealand dollar fell by about one US cent to US68.16c from just over US69c before the announcement, reflecting the extent of the market's surprise.

ANZ said it expected today's change to weigh on the New Zealand dollar for some time, and for bond yields to remain under downward pressure.

The central bank, in its statement, said employment was near its maximum sustainable level.

"However, core consumer price inflation remains below our 2 per cent target mid-point, necessitating continued supportive monetary policy," it said.

The global economic outlook had continued to weaken, in particular among some of New Zealand's key trading partners including Australia, Europe, and China.

"This weaker outlook has prompted central banks to ease their expected monetary policy stances, placing upward pressure on the New Zealand dollar," the bank said.

The balance of risks to its outlook had shifted to the downside.

"The risk of a more pronounced global downturn has increased and low business sentiment continues to weigh on domestic spending," it said.

"On the upside, inflation could rise faster if firms pass on cost increases to prices to a greater extent."

ASB's Tuffley said a key uncertainty is whether 2019 growth will pick up after a patchy 2018.

"There are still a number of supports for the economy," he said.

"But we have mounting concern that growth will not pick up sufficiently quickly to drive inflation pressures up, particularly as business confidence started the year on a softer tone," Tuffley said.

"If the economy doesn't start showing greater signs of life soon, then the Reserve Bank could conceivably cut as early as May," he said.

Westpac chief economist Dominick Stephens said it looked like the central bank, in changing tack, had an eye on the still relatively firm New Zealand dollar.

"In other words, the Reserve Bank might have tailored this statement to meet the expectations of financial markets, who are pricing OCR cuts, thereby avoiding a lift in the exchange rate," he said.

BNZ economist Doug Steel was sceptical about the prospects of a rate cut.

"We are still not convinced that it will necessarily happen, but certainly that's the way the Reserve Bank is seeing the risks," Steel said.