Lower interest rates at a cost

By BRIAN FALLOW

The dramatic slowdown in the United States economy will bring New Zealanders lower interest rates, says WestpacTrust chief economist Adrian Orr, but at the expense of harder times for exporters and slower growth generally.

As widely expected the US Federal Reserve yesterday cut interest rates half a percentage point, the second such cut in the past four weeks.

Fed chairman Alan Greenspan cited the further erosion of business and consumer confidence, reflected in weaker retail sales and business investment, having led swiftly to a sharp cut in US manufacturing production.

The Fed's rate cut is not expected to be the last and follows a slowdown in US gross domestic product growth in the last quarter of 2000 to an annualised rate of 1.4 per cent, the weakest for five years.

"Greenspan is clearly of the view that the US is headed for a pretty hard landing - zero growth in the first half of this year," Mr Orr said.

Research by Westpac suggested a 1 per cent growth slowdown in the US meant 1 per cent less growth in New Zealand, with a lag of about a year, he said. Most of that, 0.7 per cent, reflected the effect on trade - not just a reduced US appetite for New Zealand imports, but the knock-on effects on New Zealand's trade with other countries reliant on US markets, especially in Asia.

When other effects, from changes in commodity prices, exchange and interest rates, and general investor sentiment, were also factored in, the relationship was close to one-for-one, Mr Orr said.

Even allowing for no more of a US slowdown than is reflected in the consensus forecasts, though they will almost certainly be trimmed further in coming months, that would be enough to reduce New Zealand's near-term growth outlook from above-trend to below it.

"So the Reserve Bank will be looking to stimulate the economy as the year progresses," Mr Orr said.

Financial markets are pricing a local rate cut in March and another in May.

But Mr Orr is among economists who believe the Reserve Bank will remain in wait-and-see mode, holding interest rates steady, until May.

If by then it was clear that the US is facing a prolonged slowdown, a U-shaped rather than V-shaped recovery, the New Zealand interest rates would fall as well, Mr Orr said.

The markets' confidence that it would be a V-shaped recovery was founded on memories of 1998, when a flurry of Fed easings pre-empted a global credit crunch threatening to turn the Asian crisis into world-wide recession.

"That time they eased monetary policy on behalf of everyone else, not because of a broad macro-economic slowdown in the US. This time it is very different, a traditional business cycle slowdown based on past excesses having reached their limit, especially the build-up of debt by households and businesses."

The risk now is that instead of the debt-propelled spending spree of recent years the US will face what economist John Maynard Keynes called the paradox of thrift - people ramping up their savings in preparation for harder times, thereby making the downturn worse.

ABN Amro chief economist Rodney Dickens said that in an ideal world the response to slower global growth would be for the New Zealand dollar to appreciate no further, at least until the global growth outlook improved again.

But the risk is that some of the capital leaving the United States would seek a home - or at least a camp site - here instead, pushing up the exchange rate.