Rate cut catches markets napping

By BRIAN FALLOW

Reserve Bank Governor Alan Bollard's earlier-than-expected interest rate cut yesterday is being seen as evidence of a more proactive approach to monetary policy.

In his first interest rate adjustment since he was appointed last September, Bollard cut the official cash rate 25 basis points to 5.5 per cent, saying he was now more confident that inflationary pressures would ease.

"This should not be interpreted as the bank now having a more pessimistic view of the New Zealand economy, but rather as a consequence of our earlier expectations being confirmed," he said.

While drought, potential power shortages and the Sars virus posed additional risks "at this stage we do not expect a large, enduring economic impact".

Westpac economist Nick Tuffley said, "What we have seen today can be likened to a pre-emptive strike on softening inflation pressures, rather than the more reactive responses seen in some earlier easing cycles.

"The Governor appears prepared to trade off a little more volatility in interest rates against smoothing the downturn in growth, and he cited the 'avoiding unnecessary instability in output, interest rates and the exchange rate' clause in the policy targets agreement."

Tuffley said Bollard's readiness to ease when hard signs of slowing economic momentum were still relatively young suggested the easing cycle might be mild - "a stitch in time saves nine".

The move wrong-footed the financial markets and most analysts, who had expected him to wait until the next monetary policy statement on June 5.

The dollar, now looking less of a one-way bet, was sold off and interest rate markets rallied. They are now pricing in two further 25 basis point cuts in June and July.

Deutsche Bank chief economist Ulf Schoefisch said it had not taken much to change the Reserve Bank's sentiment from the hawkish stance it was taking in the March monetary policy statement six weeks ago.

The run of data since then had presented a mixed picture, Schoefisch said, with some indicators pointing to a slowdown, while others, like the housing market and immigration flows and continuing skill shortages, suggested continued strength.

"This relatively sudden change of view appears to reveal some internal disagreement at the Reserve Bank about the appropriate course of policy, with Dr Bollard at the dovish end of the spectrum.

"The return of Assistant Governor Adrian Orr, known to be a pragmatist, this month after three years in the private sector, may have tipped the the balance of the advice Dr Bollard received," Schoefisch said.

"He is giving the economy more of the benefit of the doubt than [former Governor] Don Brash would have."

Brash declined to comment on the decision, except to say that there were fairly widespread expectations that in due course there would need to be a cut.

"But like most economists I was not expecting it to be today."

National Bank economist Cameron Bagrie sees the move as reflecting a difference in risk. If the Reserve Bank had got it wrong the cost would be marginally higher inflation if the economy got its second wind, he said.

But the costs of growth falling away sharply if the bank was too slow to ease were much greater.

ANZ chief economist David Drage said the move was not without dangers.

"It provides added stimulus to areas of the economy which are still in very good shape, especially the housing market."

The shortage of skilled labour had intensified in the most recent quarterly survey of business opinion, and although headline inflation had fallen in the March consumer price index, price increases were more widespread and the weighted median measure of inflation had increased from 3 to 3.3 per cent.

"There is a better than even chance of another 25-point cut in June, but we are not convinced they will go a lot further than that, unless some of the downside risks are realised," Drage said.

In addition to Sars and the looming electricity crisis, economists' risk lists include the international and especially the United States economy, the health of which has been muddied by events in Iraq.