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OCR cut to 2% tipped, cautiously

Source: scene.co.nz

OCR-cutBNZ economists are making a "dangerous assumption'' the Reserve Bank will next week cut the official cash rate to 2% and cut it further in June.

BNZ markets economist Stephen Toplis said the assumption was based on the Reserve Bank holding a consistent line from one rate-set meeting to the next.

"If it does so, then we believe it has little option but to lower the official cash rate at its April review.''

At the same time, consistency would suggest a further reduction, leading to the BNZ moving its expected rate cut to include 0.25% cuts at both the April and June meetings, he said.

However, the BNZ made its forecasts with only modest conviction, as Reserve Bank consistency had been lacking of late.

The call was also highly dependent on the actions of the United States Federal Reserve, the trajectory of the New Zealand dollar trade-weighted index and commodity prices.

"Let's make it clear, we do not believe for a second this economy will benefit from further reductions in interest rates, which will inevitably create more economic distortions and volatility than we already have. But we are tasked with making a call on what will happen rather than what should.''

The market currently apportioned a 34% chance of a rate cut next week but Mr Toplis believed the likelihood was higher, at about 55%.

If the market priced in a rate cut more strongly, that would increase the likelihood of the Reserve Bank obliging.

The main reason for an April call by the BNZ was the ongoing strength of the New Zealand dollar and the impact it would have on the central bank's inflation forecasts.

It was "particularly dangerous'' to hang calls on currency spot rates, as they tended to move.

But if the dollar tumbled between now and April 28, the BNZ would have no hesitation in backing off its call, he said.

As things stood, the dollar appeared to have more upward momentum than down and the TWI sat at 73.12 on Friday.

That was not only higher than when the Reserve Bank delivered its March rate cut but, more importantly, was 3.1% above the level the Reserve Bank assumed it would average through the June quarter.

If the currency stayed where it was, it would take about 0.3% off the Reserve Bank's year-ahead inflation forecasts, lowering its March 2017 annual pick to 1% from 1.3%, Mr Toplis said.