A deeper economic downturn will force the Reserve Bank to cut the official cash rate (OCR) below zero in November, according to new forecasts by Westpac economists.
"We expect the RBNZ will reduce the OCR to -0.5 per cent in November 2020," said Westpac chief economist Dominick Stephens.
But while a negative OCR that would help keep mortgage rates low, it would not be expected to flow through to negative mortgage rates, he said.
"In overseas jurisdictions with negative official interest rates, retail rates have almost always remained positive," Stephens said.
"The lower the OCR goes, the less marginal impact it would have on retail rates such as mortgage rates ... a 75 basis point cut from 0.25 per cent to -0.50 per cent would bring mortgage rates down, but not by anything like as much as 75 basis
The timing was not certain and would largely be dependent on when the trading banks' systems will be ready to deal with a negative OCR, Stephens said.
In March the Reserve Bank also made a commitment to holding the OCR at 0.25 per cent for 12 months.
Stephens argued that a change to that stance would be well understood by the market given the extraordinary nature of the Level 4 lock-down.
He acknowledged cuts already made by the Reserve Bank which reduced the OCR by 75 basis points to 0.25 per cent and has committed to buying $33 billion worth of government and local government bonds.
But more was needed with inflation likely to drop below 1 per cent without further large scale fiscal and monetary policy response.
"Monetary policy not only needs to come to the party, it needs to spike the punch," Stephens said.
Even prior to the Covid-19 pandemic Reserve Bank Governor Adrian Orr had indicated a negative OCR was possible in New Zealand.
"Zero is no magic number," Orr told the Herald last year.
Negative interest rates had been operating just fine around the world and should be viewed as an extension of traditional monetary policy, he said.
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This morning's report from Westpac economists constitutes a significant downgrade to their outlook.
"We now expect a deeper decline in June quarter GDP of 16 per cent, because the Alert Level 3 restrictions are tighter than we previously allowed for," Stephens said.
Westpac also allows for a quicker move to Level two than previously assumed, resulting in a "more vigorous " third quarter rebound.
However on balance Stephens now expects the recovery phase will be slower, taking longer to overcome the damage done by unemployment and
"We are now allowing more for permanent damage to the economy, as the legacy of Covid-19 will sap productivity growth in the 2020s," Stephens said.
This was due to factors including: reduced investment, lost skills due to unemployment, domestication of supply chains and increased barriers to trade and travel, as well as higher taxation required to repay Government debt incurred during the crisis.
"Nevertheless, we still think the recovery will be a more rapid than in past recessions," he said.
Westpac's latest forecasts see Government debt rising to 50 per cent of GDP by 2024.
Unemployment is tipped to peak at 9.5 per cent, with only a slow return to below 5 per cent.
House prices are forecast to fall 7 per cent this year and will remain subdued throughout 2021.
However, we expect they will rise very rapidly over 2022 and 2023 in response to ultra-low interest rates.