The Reserve Bank is expected to cut interest rates this week, fueling belief that banks will follow suit and cut mortgage rates.

Governor Graeme Wheeler is expected to cut the official cash rate by a quarter point to 2.75 per cent on Thursday.

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Any cut will flow directly into floating mortgage rates but banks have already anticipated the cut when it comes to fixed mortgage rates.


Last week BNZ bank slashed its one year fixed rate mortgage to 4.35 per cent - the lowest rate seen in New Zealand since the 1960s.

High levels of competition among banks are also driving mortgage rates lower.

BNZ's new one-year rate has undercut a 4.49 per cent rate HSBC has been offering to its "premier" customers.

Massey University banking expert David Tripe said there was scope for mortgage rates to track even lower, possibly below 4 per cent. "If we see sub 4 per cent rates it will be because the economy has got somewhat grimmer," he said.

Tripe described BNZ's 4.35 per cent rate as an "advertising measure" that would "get people in the door".

"A one-year fixed rate is not incredibly attractive because in one year's time rates will probably be going up," he said.

"What I suspect would be of much more interest to borrowers would be [lower] fixed rates for longer terms."

Confidence has turned negative

There is also speculation Wheeler may again reduce the Reserve's forecast for economic growth, although the drop in the kiwi dollar means the bank will probably maintain its projection for inflation to accelerate through the middle of 2016.


Traders see a 78 per cent chance of a cut this week and 38 basis points of cuts in the next 12 months, based on the overnight interest swap curve.

The Reserve Bank has dialled back its estimate of annual economic growth this year to 2.5 per cent from 3 per cent and economists say the bank may lower its projections again, given the outlook for global growth has softened, Fonterra Cooperative Group's farmers are facing their lowest payout in a decade and business confidence has turned negative, falling to a six-year low.

The jobless rate has climbed to 5.9 per cent.

"While a 25 basis point OCR cut to 2.75 per cent looks to be a done deal, we see a subsequent move to 2.5 per cent as the risk scenario, and below that as unlikely," said Robin Clements, economist at UBS.

"Nonetheless, we expect the RBNZ to keep its options open by maintaining an easing bias but perhaps making it less forceful."

A bigger adjustment is likely to the Reserve Bank's forecast track for the trade-weighted index, which has sunk to about 68.61, a level the bank hadn't expected to be breached over its forecast horizon through 2017.

At the June MPS, the bank had projected an average level for the third quarter of 74.7.

Clements cites a Wheeler speech from July, where he said RBNZ modelling suggests "that a 1 per cent exchange rate depreciation boosts annual CPI inflation, albeit with a considerable lag, by around 0.1 percentage points."

NZ dollar hostage to Fed hike

The TWI's decline so far this quarter could add 0.6 percentage points to the inflation path, as it lifts the value of imports, so that "even with downgrades to other aspects of the inflation outlook, inflation is still likely to be forecast to be close to the mid-point by the middle of next year," he said.

The kiwi has fallen on expectations the US Federal Reserve will begin hiking its benchmark from near zero this year. US payrolls data came in weaker than expected, with 173,000 workers added in August, but the unemployment rate fell to 5.1 per cent, a key level for the Fed in deciding whether the labour market has recovered.

Yet the odds of a Fed rate increase at its September 16-17 meeting has fallen to just 30 percent, according to Bloomberg, which cited futures data.

Westpac Banking Corp's New Zealand chief economist Dominick Stephens says he expects this week's MPS "will strike a slightly more dovish tone than the July OCR Review and speech - that is, the RBNZ will sound a little more predisposed to lowering the OCR."

Stephens says the OCR could be cut to as low as 2 per cent early in 2016, even though Wheeler used a speech in late July to rein in economists forecasting rate cuts so steep they "could only be consistent with the economy moving into recession".

That speech "created an impression that 2.5 per cent is a 'line in the sand', below which the RBNZ will not take the OCR except in recession," Stephens said.

Still, "we remain very comfortable with the idea that, sooner or later, the RBNZ will cross the 2.5 per cent threshold," he said. "New Zealand is entering a significant economic slowdown at a time when core inflation is already well below the RBNZ's target, meaning monetary policy has a great deal of work to do." He doesn't see the weaker exchange rate generating enough inflation to offset that.

Inflation expectations are still relatively subdued. In the ANZ Business Outlook for August, firms trimmed their view for inflation in the year ahead by 2 basis points to 1.68 per cent.

The Reserve Bank's quarterly survey of expectations, released last month, showed annual inflation one year out was seen at 1.46 per cent, up from 1.32 per cent in June, and for two years out at 1.94 per cent, up from 1.85 per cent.

But other indicators are stronger. Quotable Value data shows residential property values rose at their fastest annual pace in eight years in August, led by Auckland, where values increased 20.4 per cent, outpacing a 13.9 per cent rise in the national average value for urban areas. Meanwhile, annual net migration rose to a fresh record in the year ended July 31, with the arrival of a net 59,639 permanent or long term migrants, up from 41,043 a year earlier.