UPDATED: RBNZ cuts OCR as weak dairy outlook threatens protracted low inflation; kiwi drops

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The Reserve Bank cut the benchmark rate a quarter-point and signalled more may be on the way as the dairy sector's weak outlook weighed on the nation's terms of trade and threatened to delay an increase in inflation from its near-zero level. The New Zealand dollar tumbled.

Governor Graeme Wheeler lowered the official cash rate to 3.25%, saying a more pronounced slump in export prices than expected and the prospect of waning consumer demand on increasing petrol prices threatened to keep a lid on already low inflation.

"The weaker prospects for dairy prices and the recent rises in petrol prices will slow income and demand growth and increase the risk the return of inflation to the mid-point will be delayed," Wheeler says. "A reduction in the OCR is appropriate given low inflationary pressures, the expected weakening in demand and to ensure medium-term inflation converges towards the middle of the target range.

"We expect further easing may be appropriate."

The New Zealand dollar fell as low as 70.11 US cents, from 72.07 cents immediately before the decision. It was recently trading at 70.52 US cents. The trade-weighted index dropped as low as 73.10 and was recently at 73.52 from 74.99 before the cut.

"We were surprised by the RBNZ's early cut - this is the first RBNZ move that was not clearly signalled ahead of time since the 2011 post-earthquake cut, and before that, since 2005," Dominick Stephens,Westpac Banking Corp chief economist, says.

"Markets were similarly surprised - the exchange rate fell almost two cents and two-year swap rates fell 17 basis points," he said. One consequence could be a further drop in fixed mortgage rates, which will stimulate the housing market."

Just six of 16 economists forecast today's rate cut.

Kiwibank immediately reduced its variable home loan rate to 6.4% from 6.65% while ASB cut its floating rate to 6.5% from 6.75% and says other lending and deposit rates are currently under review. ANZ Bank cut its floating and flexible home loan rates by a quarter point.

The central bank expects the country's terms of trade will be about 5% lower than in its March projections, primarily on the sharp decline in dairy prices. This suggests monetary policy needs to be more stimulatory to stoke inflation back into the target range of 1-3% annually.

Before the cut, traders had been pricing in a 40% chance Wheeler would reduce the benchmark rate for the first time since the March 2011 emergency cut, in response to the Canterbury earthquake.

Persistently low inflation, compounded by a strong New Zealand dollar, prompted some analysts to question why Wheeler hadn't cut, and the view gained momentum after the Reserve Bank and government both unveiled responses to try and cool Auckland's housing market.

Wheeler had already dropped his reference to the possibility of interest rates rising at the April review.

The central bank lowered its track for the 90-day bank bill rate, often seen as a proxy for the OCR, to 3.3% in the December quarter of this year, and bottoming out at 3.1% in June 2016 where it stays over the bank's forecast horizon until June 2017. In its March forecast, the central bank predicted the rate would stay at 3.7% through to March 2017, the end of the forecast horizon.

New Zealand's consumer price index rose 0.1% in the year ended March 31, after two quarters of contraction kept a lid on inflation. That's below the central bank's target band for inflation to be between 1-3%.

The central bank expects annual inflation to rise more aggressively on a weakening exchange rate and increasing petrol prices. The bank forecasts annual CPI will advance to a 1.6% pace by March next year, before reaching 2.1% in December next year.

The trade-weighted index was at an average 75.96 in the March quarter, below the Reserve Bank's projected level of 77 in the March forecast, and the central bank sees the TWI gradually declining to 71.4 over the horizon.

Wheeler dropped his reference to the kiwi dollar being unjustifiably and unsustainably high, explicit criteria for the central bank to intervene in foreign exchange markets. He says it is still overvalued and "a further significant downward adjustment is justified."

The slow recovery in global dairy prices and peak of the Canterbury rebuild has seen some optimism over the pace of the nation's economy taper off in recent months, and the Reserve Bank stripped out about 0.5 of a percentage point from its forecast economic growth in 2016 and 2017 March years.

(BusinessDesk)]

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