Economy and earthquake combine to force OCR down

The Reserve Bank cut the official cash rate (OCR) to 2.5 percent from 3 percent in response to the negative impact on economic activity and inflation of last month's devastating earthquake in Christchurch.
Today's move returns the OCR to the record low level in place between April 2009 and June 2010 as a result of the recession of 2008-09.
In its quarterly monetary policy statement (MPS), the Reserve Bank said the earthquake would clearly have a negative impact on activity in the near term.
``It is difficult to know how large or long lasting this impact will be, but there is a risk that the downturn is quite severe. To guard against this risk it is appropriate for monetary policy to become more supportive,'' the MPS said.
``Lowering the OCR should be regarded as an insurance measure, designed to help offset the negative effects of the earthquake until such time as rebuilding -- and a recovery in the broader economy -- act to draw on the economy's surplus resources.''
A preference by borrowers for floating rate mortgages meant any move in the OCR translated relatively quickly to the interest rates actually faced by households and firms, the MPS said.
``The (Reserve) Bank can ease policy knowing that the resultant reduction in effective interest rates can be reversed quite quickly once the economy begins to recover.''
In a statement accompanying the MPS, Reserve Bank Governor Alan Bollard said the bank extended its sympathies to all those affected by the Christchurch earthquake.
``Our condolences go especially to those who have lost family, friends and colleagues,'' Dr Bollard said.
Even before the earthquake, through the second half of 2010 growth in gross domestic product (GDP) had been much weaker than expected.
``Households have continued to be very cautious, with retail spending volumes and residential investment both declining. The export sector has benefited from very high commodity prices, however, farmers have focused on repaying debt rather than increasing spending. Also the early summer drought constrained farm output through this time,'' Dr Bollard said.
Signs the economy was beginning to recover early in 2011 had been more than offset by the earthquake.
The MPS warned that in putting together its forecasts, the Reserve Bank had needed to make many important assumptions based on quite limited information.
It said the February earthquake was likely to reduce consumer and business confidence, as economic uncertainty could see households trim spending and firms delay investment plans. Such an effect could be felt for many months.
At this early stage it was difficult to quantify those effects, but it seemed quite possible GDP would contract in the March quarter.
It was estimated March quarter GDP would be 0.6 percent lower than would otherwise have been the case, mainly due to reduced household and business spending, as well as lost exports and lost production in sectors such as real estate, construction and tourism.
Once the immediate negative impact of the earthquake subsided, several factors were likely to help the economy recover, the MPS said.
While there were risks to the global outlook, growth in the Asia-Pacific region continued to be robust, and the US and Europe were growing more strongly than expected.
Tourism activity would pick up in September for the Rugby World Cup, with visitors expected to add $700 million to the economy during the six weeks of the event, about a third of a percent of GDP.
Beyond that, services exports were likely to increase only modestly, due to high debt in Western trading partners, along with some discouragement of tourism as a result of the earthquake, the MPS said.
Eventual reconstruction activity in Canterbury would add significantly to GDP. While it was difficult to know when rebuilding would start, the Reserve Bank projections assumed reconstruction starting in 2012.
It was assumed construction sector activity would quickly rise to an elevated share of GDP, similar to that during the building boom of the mid-2000s, and hold there for several years.