RBNZ cuts OCR as cheap oil saps inflation expectations

See also: RBNZ: Wheeler cuts OCR, signals more on way

Reserve Bank governor Graeme Wheeler cut the official cash rate a quarter point to 2.25% and hinted the rate could go lower, in a bid to prevent cheap global oil prices being imbedding in to the way local firms set wages and prices. The kiwi dollar tumbled after the unexpected move.

"While long-run inflation expectations are well anchored at 2%, there has been material decline in a range of inflation expectation measures," Mr Wheeler says. "This is a concern because it increases the risk that the decline in expectations becomes self-fulfilling and subdues future inflation outcomes."

Mr Wheeler had been reluctant to lower the benchmark rate in the face in the face of flat inflation, and last month called a fixation on the headline consumer price index a "mechanistic approach" to monetary policy that ignored his ability to look through price shocks.

However, a fortnight later, the Reserve Bank's quarterly survey of expectations showed firms' perceptions of inflation were at their lowest since 1994.

Today he cut the benchmark rate 25 basis points to a record low 2.25% and lowered the forecast track to the 90-day bank bill rate, often seen as a proxy for the OCR, by half a percentage point over the next two years, implying another reduction is still to come.

"Headline inflation is expected to move higher over 2016, but take longer to reach the target range," Mr Wheeler says. "Further policy easing may be required to ensure that future average inflation settles near the middle of the target range."

A rebound in the New Zealand dollar from its trough in September was feeding into the weak inflation outlook, making imports cheaper and its resilience has been a persistent thorn in the Reserve Bank's side by sapping inflation in tradable goods and services. The trade-weighted index was 4% higher than the bank's December projection and Mr Wheeler says "a decline would be appropriate given the weakness in export prices."

The New Zealand dollar dropped to 66.63USc from 67.77USc immediately before the statement. The trade-weighted index fell to 71.53 from 72.70.

The global slump in oil prices, heightened market volatility in financial markets, and the extension of extraordinary monetary policy by some central banks to introduce negative interest rates stoked expectations the Reserve Bank would have to lower the OCR.

Kiwibank economists were the only local forecasters predicting a reduction at today's meeting, and traders had been pricing in an outside chance of an early move.

Today, Mr Wheeler says cheap fuel and other imports continued to weigh on headline inflation, which has been below the central bank's target band of 1-3% since September 2014. Stripping out "transitory price movements" annual core inflation was at 1.6%.

The Reserve Bank doesn't expect the CPI to get back within the band until the December quarter this year, and anticipates it won't be at Mr Wheeler's targeted mid-point of 2% until March 2018.

Two key risks that could prompt even lower interest rates were if imported inflation was lower for longer than the central bank's projections, and also if global investors lost their appetite for risk-sensitive assets, which would push up local banks' funding costs and likely lead to higher mortgage rates.

Conversely, if the current level of the OCR stokes a resumption of rapid house price appreciation and domestic consumption that would need rates to rise.

The Reserve Bank expects gross domestic product will continue to grow at largely the same pace over the forecast horizon as strong tourism, a building pipeline of construction work, and low interest rates stoke activity.

(BusinessDesk)