There was something very clear and direct in New Zealand yesterday morning with the country’s central bank slashing its key interest rate 0.50 to 7.5% and declaring the economy was in recession.
That cut was more than most economists had forecast and indicates just how gloomy the New Zealand Reserve Bank is now about the health of the Kiwi economy.
In fact the cut was one of a central bank hacking at rates to send a big message to everyone in the country about the extent of the problem in the economy and the dangers from the slowdown; much in the way the US Federal Reserve cut rates by 0.50% during the credit crunch and in early January, 2001 when the tech boom starting collapsing.
It is definitely not the act of a confident central banker.
In fact some New Zealand economists said in commentary afterwards that the Governor’s credibility was now on the line and that there was a danger the big rate cut could exacerbate the continuing high levels of inflation.
The economy contracted in the first quarter and although official growth figures are not due until September 26, the bank’s head, Dr Alan Bollard said in a statement: that the economy had contracted in the second quarter as well.
That was a turnaround from the bank’s June economic forecast of small growth.
But he said that with the medium-term inflation pressures expected to ease, it was now "appropriate to move toward a less restrictive stance”
He said the half a per cent cut "is warranted in light of tightness of credit conditions and the time it will take to affect actual interest rates faced by households.”
Mr Bollard joined the NZ Treasury and private economists in forecasting the economy also contracted in the three months to June 30, putting the nation in its first recession since 1998.
Bollard said inflation will return below the 3% limit of his target range by the first quarter of 2010.
The RBNZ believes inflation will probably hit 4.9% in the year ending September 30, the fastest since 1990. Inflation should then start slowing to 4.5% by March 2009, and to 2.8% a year later.
Yesterday’s rate cut came after the central bank cut rates in July by 0.25% from the record 8.25%.
The New Zealand dollar fell under 66 US cents after the cut was announced, to be down by around three quarters of a cent in less than an hour. It touched a low of just over 64.60 cents, the lowest early October 2006.
Governor Bollard said in the statement announcing the cut: “The New Zealand economy is experiencing a marked slowdown, led primarily by the household sector.
"The outlook for the global economy has deteriorated further in the wake of continued financial market turmoil.
"In addition, the New Zealand business sector is coming under pressure from both rising costs and falling demand.
"While domestic activity is likely to pick up late this year as a result of personal tax cuts, increased government spending and rising rural incomes, we expect a prolonged period of household sector adjustment and below-average growth.
“The weakness in economic activity is expected to translate into lower inflation pressures in the medium term.
“Headline inflation is expected to peak around 5 percent in the current September quarter before trending down thereafter. However, food price inflation, exchange rate depreciation and higher wage costs will tend to keep headline inflation at elevated levels through 2009.
“With medium-term inflation pressures expected to ease, it is appropriate to move towards a less restrictive monetary policy stance.
"Compared to the June Monetary Policy Statement, we have brought forward some of the projected interest rate reduction, but have not altered the expected overall decline.
“We believe this response is warranted in light of the tightness of current credit conditions and the time it will take to affect the actual interest rates faced by households and businesses.
“Looking ahead, the scale and timing of further official cash rate reductions will depend on signs of declining inflation pressures and on exchange rate adjustments.”
It was the largest cut by the RBNZ since two 0.50% cuts in the wake of September 11.
The central bank put the second quarter contraction at 0.2% after forecasting 0.2% growth in the June policy statement.
The RBNZ said economy will also contract by 0.3% in the third quarter and growth in the year to March 31, 2009, will be 0.3%, the weakest in 10 years.
