Rates cut to 2.5pc

Richard Baron / Fairfax Media

Richard Baron / Fairfax Media

The Reserve Bank has dropped official interest rates to a new low of 2.5 percent and is promising low rates at least till the end of next year.

The decision, just announced by RBNZ Governor Alan Bollard, was as expected by a majority of economists.

The move continues a massive series of cuts since July when the Official Cash Rate stood at 8.25 percent, taking the OCR to its lowest level since it was created in 1999.

The news gave the Kiwi dollar a bit of a jolt. It dropped about three-quarters of a cent against the American currency and was just under US56.5c a short time ago.

“We consider it appropriate to provide further policy stimulus to the economy,” Bollard said.

“We expect to keep the OCR at or below the current level through until the latter part of 2010. The OCR could still move modestly lower over the coming quarters.”

The latter comment goes against Bollard’s own words just last month when he said he saw interest rates bottoming at 2.5 percent. The market has been looking for a definitive assertion from the RBNZ that rates would stay low for a long time – and got it today.

The words from the governor have already prompted one bank – Westpac to move on its rates.

Westpac New Zealand has confirmed a 0.4 percent cut to its 6-month fixed housing lending rate. This brings its 6-month home loan rate to 5.39 percent. The rate will be effective from Friday.

Westpac General Manager of Product Management, David Cunningham said: “An important implication of the OCR announcement is the signal from the Reserve Bank that it intends for interest rates to remain low for an extended period. This will provide considerable cash flow benefit to New Zealand home owners with mortgages.”

Bollard has been cutting rates in response to the fact that New Zealand’s economy has been in recession since the start of 2008. Economists suggest there may now be very early signs that a recovery is on the horizon.

The latest National Bank business outlook survey released yesterday recorded the biggest improvement in sentiment among Kiwi companies since the December 2000 survey. “A turning point appears to have been reached for the economy,” National Bank chief economist Cameron Bagrie said.

The extent to which the latest reduction in official rates will be passed on to homeowners through lower mortgage rates is a key question, however.

Bollard has not been slow to prod the banks into action and he was at it again today – gently.

“We expect the large decline in the OCR over the past year to pass through to more borrowers over coming quarters as existing fixed-rate mortgages come up for re-pricing,” Bollard said.

Banks have been indicating increasing difficulty in passing on official rate reductions because the cost of money they are sourcing from overseas remains relatively high.

BNZ chief economist Tony Alexander told BusinessDay prior to today’s decision that even if the OCR eventually hits 2 percent – as he is predicting – it is unlikely either the retail banks’ fixed or floating home loan rates will come down much further.

Alexander says that is because the local banks borrow 40 percent of their funding from overseas and the turmoil in international credit markets is forcing them to pay more to secure that funding than in the past.

“You should not expect to see the floating rates coming down much more…I would not expect a 100 percent feed-through [of OCR cuts],” Alexander said.

The run-up to today’s rates review made the decision arguably the most fascinating – and hard to predict – since the bank started reducing rates last year.

While Bollard had chopped another 50 basis points off the official rates at the last review in March, he also talked the about the rates being on a “glidepath” to 2.5 percent. At the time most of the economists had been predicting a bottom of the cycle rate of 2 percent or even lower.

Bollard’s comments were taken by some in the market to mean that interest rates may actually be going UP again quite soon.

As a result of this, the wholesale interest rates charged between the banks started rising and the Kiwi dollar began to surge. Thousands of New Zealanders clamoured to fix long-term mortgage rates, fearing that they had missed the “cheap” rates. This itself, put more upward pressure on the rates.

Bollard was moved to the most unusual step of putting out a media release early this month saying that the rise in long-term wholesale interest rates was “out of line” with the RBNZ’s expectations.