NZ central bank to cut rates in next 3 months

The Reserve Bank of New Zealand is likely to cut interest rates in the next three months as growing evidence of a slump in economic growth outweighs concern about speeding inflation.

Friday, July 18th 2008, 9:57AM

by Jonathan Underhill

The bank will keep the official cash rate unchanged at 8.25% at its July 24 review, according to nine of 12 economists in a Good survey this week. Three predict a 25 basis points cut. Of those picking no change next week, six economists say the bank will move on Sept. 11.

Governor Alan Bollard faces an ugly mix of inflation that has soared above his 1% to 3% target range in an economy that probably tipped into recession this year. Some economists predict annual inflation will peak at more than 5% in the third quarter, well above the central bank's 4.7% forecast.

"It is a tough call for a central bank with an economy probably in recession but inflation stubbornly high and rising," Doug Steel, economist at Westpac Banking Corp., told Good Returns. Bollard "will be wary of cutting too aggressively, raising the possibility of having to make an embarrassing U-turn."

New Zealand was the first nation in the world to adopt an explicit central bank inflation target, in 1990, a target that has become the norm for central banks.

Prolonged Effects

The Policy Targets Agreement allows Bollard to look through short-term price shocks as he seeks to control inflation through an 18-month horizon. Soaring global prices for food, fuel and raw materials, which the bank can't control, are having a prolonged impact on prices.

Inflation accelerated in the second quarter to the fastest pace in 18 years, with the annual 4% rate faster than the 3.8% annual pace predicted by economists and the central bank.

Still, non-tradables inflation (generated domestically and not influenced by the exchange rate) was 0.9% in the second quarter, less than the central bank's 1% estimate.

Economists including Bank of New Zealand's Stephen Toplis this week said the central bank's decision whether to cut rates next week or in September may come down to the weight it puts on an inflation measure excluding food and energy.

"The RBNZ might just buy itself some more time," Toplis said in a note this week. "Whatever the case, the easing cycle is about to begin and it should be a long one, as monetary policy is called upon to drag the New Zealand economy from its current malaise."

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