Traders see outside chance Reserve Bank will cut OCR below 2% next week

Traders say a Reserve Bank interest rate cut next week is a foregone conclusion and a minority are betting the stubbornly high kiwi dollar is a big enough threat to its policy targets to prompt governor Graeme Wheeler to reduce the official cash rate by 50 basis points in one move.

The overnight index swaps market has priced in an 86% chance the OCR will be cut a quarter point to 2% at the August 11 review and a 14% chance of a steeper cut to 1.75%, according to Reuters data. Mr Wheeler signalled a rate cut was imminent in his unscheduled economic update last month saying "further easing was likely."

Economists do expect Mr Wheeler to ease by 50 basis points but to spread out the easing, with a 25 basis point reduction next week and a second cut in November.

"Some in the market are asking whether the Reserve Bank could choose to cut by 50 bps in August," HSBC Australia and New Zealand chief economist Paul Bloxham said in a note. "We doubt this is likely, as it would give the sense of an emergency situation, which we do not believe New Zealand faces."

The Reserve Bank last cut the key rate by half a%age point in March 2011 in response to the second Canterbury earthquake, which  levelled large portions of the city and killed 185 people. Prior to that, the bank made six cuts of half a%age point or more through 2008 and 2009 in response to the global financial crisis.

Mr Bloxham says New Zealand's economic growth is holding up well, though the weak inflation outlook and tepid wage increases probably warrant a second reduction to the OCR in November.

"Two more cuts before the end of 2016 should also narrow New Zealand's interest rate differential with other major markets, particularly Australia, where we do not expect any further cuts from the Reserve Bank of Australia and the US (where the Fed's next move is still likely to be up, with our US economists expecting a hike in the second quarter next year)," Mr Bloxham said. "This could ease some of the upward pressure on the New Zealand dollar."

Mr Wheeler has been contending with a currency which has overshot the central bank's expectations, making imported goods and services cheaper and adding to the low inflation environment. At the same time, he's been reluctant to cut interest rates too aggressively for fear of inflaming a housing market that's already straining under a supply shortage. Despite his various attempts at jawboning the kiwi lower, the currency's relatively attractive yield has kept it well bid.

Michael Gordon, Westpac Banking Corp's acting New Zealand chief economist, said the stronger exchange rate was about 6% higher than the Reserve Bank's projections on a trade-weighted basis. The trade-weighted index was recently at 76.14 compared with the 71.6 average the central bank had projected for the third quarter.

"A 'miss' of that size is fairly extreme, though not unprecedented, and it will put a severe dent in the RBNZ's tradables inflation forecasts," Mr Gordon said in a note. "Consequently, a lower interest rate path is needed to keep overall inflation on track to return to the target over the medium term."

Westpac now sees Mr Wheeler cutting next week and also in November, and that "the risks are towards a larger reduction in the interest rate track." A 25 basis point cut and guidance for further easing would be "a broadly neutral result for the market," Mr Gordon said.

(BusinessDesk)