Way open for rate cuts

The Reserve Bank has today left the Official Cash Rate (OCR) unchanged at 5.75% and opened the way for cuts in both floating and fixed rate mortgages.

Essentially, the decision was a balancing act between an increasingly problematic global economy and worries over domestic inflation.

Since the May monetary policy statement, "prospects for the international economy have become increasingly clouded, with sharp falls in equity markets and heightened investor nervousness in the US and elsewhere," acting governor Rod Carr says.

On the other hand, "indicators of core inflation have edged up to around 3% following a sustained period of higher-than-average pressure on the country's productive resources. "

"For now, the prudent response is to pause, and to watch and wait," Carr says.

The bank's decision follows the US Federal Reserve's decision earlier today to leave its Fed funds rate at 1.75%, although it changed its stance from neutral to an easing bias, warning the economic risks are now tilted toward weakness.

While Carr’s decision surprised nobody, the dovish tone of his statement did.

In May, the bank had thought further rate raises would be needed to keep inflation in check, now that looks less likely, Carr says.

Certainly, the wholesale interest rate market interpreted it as signaling further interest rate rises are unlikely.

While the 90-day bank bills were unchanged at 5.85%, the December 90-day bank bill futures dropped from 6.02% late yesterday to 5.82% within an hour of the statement.

"The market has basically priced out any OCR rises for the rest of the year," Bancorp Treasury Services associate director Peter Cavanaugh says.

Stephen Toplis, head of market economics at Bank of New Zealand, who had rated the chances of a rate rise today at 50%, says "it’s very much a statement couched in the uncertainty of the times. If things pan out as (the central bank) assumes, there will be little reason for it to move rates again in either direction," he says.

But ANZ Bank chief economist David Drage, sees the decision as "very much a calculated risk" and a "bit of a leap of faith."

Unless the global economy does go into a double dip recession, he still thinks the OCR will need to go to 6% in November and to 6.5% in the first half of next year.

Commenting is closed