Bollard signals further rate cut

By BRIAN FALLOW

Reserve Bank Governor Alan Bollard yesterday delivered an interest rate cut, signalled the prospect of another, but moved to douse market expectations of one beyond that.

As universally expected, he cut the official cash rate from 5.5 to 5.25 per cent and said the bank's projections incorporated "a further modest reduction in the OCR", contingent as ever on further evidence that medium-term inflation pressures are abating as the bank assumes they will.

But the statement disappointed those in the financial markets who were pencilling in a further cut to 4.75 per cent in this easing cycle, and there was a mild sell-off of 90-day bill futures.

Westpac chief economist Brendan O'Donovan said Bollard had put a floor under interest rate expectations, but there might yet prove to be a trapdoor in it if world growth did not improve as expected.

While most market economists thought Bollard had got it right, Deutsche Bank chief economist Ulf Schoefisch said the easing was too modest.

"With growth coming off quickly, inflation pressure subsiding and the world environment pointing to significant further rate cuts by the Federal Reserve and the European Central Bank, the Reserve Bank's move appears too cautious.

"While New Zealand's high rates in the global context were justified when the economy was growing at 4.5 per cent, they look abnormally high considering that growth has been slowing towards 2 per cent and below," Schoefisch said.

The bank thinks growth peaked late last year and is heading towards a soft landing of 2 per cent in the current March year.

But it forecasts a rebound to about 3.25 per cent in the year to March 2005 under the influence of global recovery, the dollar falling on a trade-weighted basis and the present easing in monetary policy.

The risks to this scenario are skewed to the downside, it says.

It believes the very low levels of business confidence recorded in the sentiment surveys are not a good reflection of the underlying economic situation or actual business attitudes.

But it could be wrong about that and realises that if such weak sentiment persists, it can be self-fulfilling if it retards business investment.

"We don't regard that as a major risk at the moment," Bollard said.

The bank's forecast assumes that the exchange rate will ease back towards a long-term average level on a trade-weighted basis over the medium term.

But it acknowledges the risk that continued weakness in the US dollar will see the kiwi rise further on that cross rate, even though that has been offset by an easing against the Australian dollar.

The other major area of uncertainty is the international environment, the risk being that the forecast recovery in growth among New Zealand's main trading partners from 2.5 per cent this year to 3.3 per cent next year will not be achieved.

Bollard was at pains to pre-empt an over-reaction later this year to what the bank expects to be a weak, even negative, GDP number for the June quarter.

That would reflect factors like the impact of the Sars virus, production cutbacks because of high spot electricity prices and the bringing for