Reserve Bank gives in to pressure with massive OCR cut

RBNZ bows to pressure and makes big cash rate cut RBNZ says was a toss up between 25 and 50 basis point cut Economy weak and subdued because of high rates RBNZ gives little away on the next move, but another 50 bps expected in November

Analysis - Over the decades the Reserve Bank has been keen to emphasise its independence and remind financial markets and the economic chattering classes that it's in control.

But its latest decision to slash the OCR by 50 basis points to an 18-month low of 4.75 percent has all the hallmarks of bending with the prevailing wind, which had been gathering hurricane force in the past week.

The short statement and summary of the meeting of the Monetary Policy Committee (MPC) said the double sized cut was justified by the subdued and weak economy, rising unemployment, external risks, and the confidence that inflation is finally back in the 1-3 percent target band

The August monetary statement had the whiff of panic about it as the weekly and monthly drip of economic numbers and surveys painted an ever more dismal picture of the economy, prompting the start of the easing cycle with a 25 bps cut, and a signal that interest rates would be gradually reduced over the next couple of years.

Regular or supersized cuts?

The MPC summary said the latest decision was a toss up between a regular sized 25 bps cut or the supersized 50 bps, which it said was in line with the economic indicators, and market expectations.

But it also said the OCR was still "restrictive" - that is, keeping the foot on the economic brake pedal, which will still weigh on consumer and business spending and likely contribute to higher unemployment.

The RBNZ has given little away on the next move - although almost nobody is contemplating anything but another cut of most likely 50 basis points to 4.25 percent in late November.

What next?

The RBNZ will be watching the economic numbers - especially the inflation rate for the September quarter due out on 16 October, and the labour market numbers on 6 November.

The former should see annual inflation well below 3 percent, while the jobless rate will likely inch closer to 5 percent from the current 4.6 percent.

That leaves open the strategy for 2025 - businesses had been talking about a plan to "survive through '25" from the previous "survive till '25", but with the cash rate on the fall the hopes are that the economy will improve.

However, the RBNZ may well see that it's given the economy the immediate sugar rush it was craving and that a more measured pace of cuts may be justified. Once again it will be driven by the economic numbers.

The central bank will be mindful that stubborn sources of domestic inflation exist - the unholy trinity of rates, rents and insurance.

In addition, it will be watching for any signs that New Zealanders are readying to engage in the national sport of exuberant house buying.

Then there are the geo-political and global economic worries such as the Middle East conflict and China's economic performance.

All that points to a return to gradualism - 25 basis points a meeting, or even every other meeting.

When will lower rates filter through?

To some extent they already have, with wholesale rates steadily falling over the past couple of months, flowing through to retail lending and deposit rates. Retail banks have wasted no time in passing on the latest cut to their floating mortgage and business rates.

But central bank rate cuts usually take between nine and 18 months to work their way through the economy.

And many borrowers will have locked in longer term fixed mortgages, which they have to decide whether to break to chase a lower rate or hang in until they refix. In such circumstances there will be winners and losers.

How low will the RBNZ go?

It all comes down to the so-called "neutral" level of the official cash rate, a 'Goldilocks rate' which neither stimulates nor constrains economic activity.

Clearly it is an educated guess based on prevailing economic conditions, and for every economist there's a different guess, with the current range between 2.75 percent and 3.5 percent perhaps by early 2026.

Popular term lending rates usually sit a couple of percentage points above the OCR, which suggests retail rates dipping below 5 percent for some durations but not much more. The days of pandemic-driven bargain basement rates are over.

Another consideration for retail banks is their need to attract money from local savers to help fund their lending, so while they want to pay the least possible if deposit rates are too low, investors look for better returns such as sharemarkets.

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