A crack in the hardline monetary policy approach across the Tasman as New Zealand’s Reserve Bank is forced to admit that you can’t run a gung-ho anti-inflation policy in the face of a tanking economy.
Alan Bollard, the Governor of RBNZ surprised when he revealed he was ‘likely’ to cut interest rates later this year. For the time being he left the Official cash rate steady on 8.25%.
The signalled move compares to the on hold policy at the Bank of England, despite the British economy tanking as fast as New Zealand’s and the big hint last night that the European Central Bank will be lifting its key rate from 4% very soon.
In a detailed Monetary Policy Statement Mr Bollard made it clear the outlook for the NZ economy was poor, to depressing.
"The outlook for economic activity is now weaker than in our previous Statement real household spending – the main driver of economic growth over the past few years – is now projected to contract over the next couple of years."
That would normally be sufficient to get a cut going immediately.
And it isn’t good news for all those Australian businesses operating across the Tasman, the four big banks, Woolworths, Fairfax, Caltex, APN News and Harvey Norman.
NZ isn’t a major place for doing business and generating earnings: it’s smaller than Sydney in some respects, but with Australian domestic demand slowing amid high inflation; it will be a double whammy to many of these businesses that they were not expecting.
But inflation remains a concern and Mr Bollard blamed the rapid rise in oil prices:
"Oil prices have increased by more than 30 percent over that time to new all-time highs. In real terms, oil prices are now above the levels experienced in the 1970s."
He also pointed out that food prices were now rising and becoming a concern.
So it seems to be for that reason that the OCR wasn’t cut yesterday.
Now the speculation will be on when the cut will come and a result the NZ dollar fell sharply as traders gave it up.
The currency fell almost 2% in the aftermath of the policy switch to just under 77 USc, and then fell to around 76.90 USc. The currency had closed at 78.30 USc the day before.
Coming on top of the big policy switch by the US and the US Federal Reserve towards favouring a stronger greenback, the impending rate cut (even if it’s to only 8%) will mean difficult and volatile trading days ahead for the Kiwi currency.
It now seems so far away from the all-time high of 82.13 USc hit in mid in March as international investors took advantage of the 8.25% rate and apparently solid economic performance.
Since then the economy has turned down sharply, with every major indicator pointing downwards, except inflation.
On top of this the national government’s recent budget committed the Labour Party administration to tax cuts and a budget deficit for the first time in nine years, moves that would normally help support the currency.
Mr Bollard has kept the OCR unchanged since last July to slow domestic demand.
He now says the economy contracted in the first three months of the year with retail sales and employment falling and house sales slumping in April to a 16- year low.
In a statement released with the decision Mr Bollard said:
"Consistent with the Policy Targets Agreement, the Bank’s focus will remain on medium-term inflation.
"Provided the economy evolves in line with our projection, we are now likely to be in a position to lower the OCR later this year, which is sooner than previously envisaged.
"The global economy is currently experiencing significant increases in oil and food prices.
"These price increases are occurring at the same time as activity is weakening in many economies in response to the global credit crisis and slowing housing markets. In New Zealand, this confluence of factors is producing a challenging environment of weak activity and high inflation.
"We project annual CPI inflation to peak at 4.7 percent in the September quarter of this year.
"Although much of this reflects higher food and energy prices, underlying inflation pressure also remains persistent.
"Nevertheless, we do still expect inflation to return comfortably inside the target band over the medium term.
"This is based on the expectation that commodity prices stop rising, inflation expectations remain anchored, and weakening economic activity contributes to an easing in non-tradable inflation.
"The outlook for economic activity is now weaker than in our previous Statement. We project little GDP growth over 2008 and only a modest recovery thereafter, largely reflecting a weaker household sector.
"Government spending and personal tax cuts will provide some offset to this lower growth but will also add to medium-term inflation pressure."
On inflation, a detailed assessment of the NZ economy in the longer Monetary Policy Statement said:
"Reflecting these ongoing international commodity price increases, the near-term inflation outlook in New Zealand has deteriorated considerably since the time of the March Statement, such that annual CPI inflation is now projected to peak at 4.7 percent in the third quarter of this year.
“The main reason for the upward revision relative to March is that oil prices have increased by more than 30 percent over that time to new all-time highs.
"In real terms, oil prices are now above the levels experienced in the 1970s. Furthermore, the inflation that occurred in dairy prices in late 2007 now appears to be occurring in other food groups, such as breads and cereals.
"Although we expect all of t
