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12-09-2008

Bollard cuts rates more than expected

Reserve Bank governor Alan Bollard surprised the market with a bigger-than-expected interest rate cut, citing a marked slowdown in household spending and a deteriorating global economy.

Bollard cut his official cash rate (OCR) from 8% to 7.5%. All 10 economists surveyed by GoodReturns last week had been expecting a cut to 7.75%.

The biggest market reaction was in the currency which dropped from 66.20 US cents to 65.32 half an hour after the decision was announced. Wholesale interest rate markets had already been pricing in aggressive rate cuts through the rest of the year so the reaction was more muted with the one-to-five year swap curve down about 10 basis points.

One reason economists are surprised is when Bollard cut the OCR in mid-July, his first cut since July 2003, he signalled further rate cuts provided there was "no excessive exchange rate depreciation" and the currency has already declined further than Bollard was projecting then.

"They seem to have gone for the: ‘let’s get on with it’ approach," says Robin Clements, an economist at UBS New Zealand.

"It’s easy enough to lis6t the reasons to be aggressive and the reasons not to be and I though the reasons not to be were more convincing."

Normally the central bank only makes 50 basis point cuts in times of emergency such as after the September 11 terrorist attacks in 2001. It’s hard to detect any similar crisis now "unless they know something we don’t," he says.

Nick Tuffley, chief economist at ASB Bank, says Bollard seems to want to ensure the impact of the rate cut gets though to borrowers relatively quickly. A 25 point cut was already priced in and wouldn’t have meant lower effective rates, he says.

"A lot of the motivation behind the cut seems to be there’s a better chance of getting easier financial conditions through to households and businesses in this environment where the global credit markets are still pretty tight."

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