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15 Aug 2016

Rates cut to Record Lows

Interest rates have hit record lows, with the Reserve Bank of New Zealand (RBNZ) cutting rates by 25 basis points to 2 percent in an effort to stimulate growth and keep the economy in check. With negative interest rates operating in countries across the world, including those that represent a quarter of world output, the RBNZ had to move in an effort to stem currency growth and prevent deflation.

After years of hesitation and gradual rate reductions, New Zealand has become the latest developed nation to join the low rates club. The official cash rate has dropped significantly from its recent peak of 3.5 percent in June 2015, as the central bank attempts to rein in the currency and support the dairy sector. According to RBNZ governor Graeme Wheeler, "The high exchange rate is adding further pressure to the export and import competing sectors... This makes it difficult for the bank to meet its inflation objective."

Consumer price inflation is currently running at just 0.4 percent, well below the RBNZ’s target range of 1-3 percent. Further easing may be needed to help bring inflation into range, with Wheeler saying “Our current projections and assumptions indicate that further policy easing will be required to ensure future inflation settles near the middle of the target range," adding that "The prospects for global growth and commodity prices remain uncertain."

While the impact of low rates is confused by solid economic growth and a hot housing market, the biggest problem at the moment is the failure of the currency market to play ball. The Kiwi dollar took off as soon as the interest rate decision was announced, with the New Zealand dollar jumping about 1 percent in a widely unexpected move to reach $0.7351. While the Kiwi has settled since then, it's fair to say the battle against excessive currency is not going well.

While further rate cuts are likely at some stage if current conditions continue, Wheeler downplayed concerns that the RBNZ might take excessive policy measures to push inflation back into target: “You have to think about what life is like in an economy that is likely to grow at around 3.5% if you suddenly race to the bottom with interest rates,” he told a recent parliamentary commission, adding “Just think what the housing market would be doing if we race to the bottom and use up all our capacity on monetary policy."

In an effort that may simplify future decisions, the RBNZ recently announced new macro- prudential tools aimed at curbing high-velocity house price growth. According to Jarrod Kerr, a senior interest rate strategist at Commonwealth Bank of Australia, even with booming house prices, the RBNZ may be forced to make another downward move quicker than it hopes: "Central banks are ‘reluctant cutters’ as they head towards lower bounds... Frustrations over currency strength and inflation expectations eventually overpower policymakers because it is a global theme and a theme the RBNZ cannot escape,” said Kerr, who has predicted rates of 1 percent over time.

Image source: Art3D / Shutterstock