NZ: No Rate Cut Despite Economy’s Fading Strength

Australia's Reserve Bank cut rates this week, but NZ's Reserve Bank resisted the temptation to follow and sat pat yesterday, leaving its key rate at 2.5%, despite warning that the economy is slowing.

The decision was matched in Seoul by South Korea's central bank which left its key rate unchanged on 3.25%.

So far this week Australia has sat as did the Bank of England overnight and Canada earlier in the week. Brazil and Thailand have cut rates and the big one was the cut overnight by the European Central Bank in its key rate.

In New Zealand, a cautious Governor Alan Bollard said in a statement in Wellington issued yesterday

"Given the current unusual degree of uncertainty around global conditions and the moderate pace of domestic demand, it remains prudent for now to keep the cash rate on hold."

"Continuing difficulties related to sovereign and bank debt in a growing number of European economies have resulted in high levels of volatility in financial markets," Mr Bollard said in the post meeting statement

"There has also been a softening in international economic activity, including in the Asia-Pacific region."

"Global developments are having some negative impact on New Zealand, though to date it has been limited."

The central bank's decision wasn't surprising, but it came after it joined the country's Treasury in downgrading growth forecasts for then next year or two, blaming the impact of the eurozone crisis.

"There remains a high degree of uncertainty around the global outlook and, as discussed in the scenario in this Statement, there is a risk that conditions weaken further.

"Domestically, economic activity continues to expand, though at a modest pace.

Although off their peaks, export commodity prices remain elevated. In addition, the depreciation of the New Zealand dollar provides some support for the tradable sector of the economy.

Over time, repairs and reconstruction in Canterbury will also provide a significant boost to demand for an extended period.

"Annual headline inflation is estimated to have returned within the Bank's 1 to 3 percent target band in the December quarter.

Underlying inflation continues to sit close to 2 percent. In addition, wage and price setting pressures have remained contained.

"Given the current unusual degree of uncertainty around global conditions and the moderate pace of domestic demand, it remains prudent for now to keep the OCR on hold at 2.5 percent."

The move saw a small sell off in the Kiwi dollar, which has fallen nearly 7% in the past three months. But the current regained most of the losses and closed around 77.87 US cents, down 0.10 of a cent on the day.

Mr Bollard omitted any reference to future cash rate increases which he included in statements in October and September.

The central bank forecast the three-month bank bill yield will be 3% in the second quarter of next year, down from 3.7% in its September projections. The bill yield forecasts are seen as a guide to the level of the cash rate.

In its monetary policy statement, also issued yesterday, the RBNZ said the country's economy is growing at a slower pace than previously projected.

Subdued domestic demand and uncertainty about global conditions have curbed business sentiment. "Business confidence has declined and investment spending is likely to remain weak for some time," Mr Bollard said.

The bank cut its growth forecast for the current financial year and the next one.

The economy will grow 2% in the year ending March 31, 2012, down from 2.8% forecast in the September policy statement. Growth will improve to 2.9% in the 12 months to March 2013 and 3.2% the year after (although that's a bit rubbery, like all forecasts that far out).

Export growth will fall over the rest of the financial year to next March.

While a weaker local currency helps exports, it also fans inflation, which will be stronger than previously expected in 2012 and weaker in 2013, today's report showed. Still, underlying inflation "continues to sit close to 2 per cent," Mr Bollard said.

On Monday the NZ Treasury cut its forecast.

"The Treasury's pre-election forecasts assumed that European governments would manage the crisis without too much more damage to the real economy, but financial tensions have escalated and dragged down growth forecasts in the region and across our major trading partners," it said.

It now expects New Zealand's economic growth for that period to be "closer to 3% than the 3.4% we had forecast in the Pre-Election Update," it said.

"It is likely that growth will also be lower in subsequent years, but it is too early to judge how material those impacts might be," it added.

The Treasury also said its projected tax revenues across its four-year forecast period would also likely be lower than forecast. In the Pre-Election Update, Treasury said that should its so-called "downside scenario" eventuate, tax revenue would be around NZ$14.5 billion (US$11.3 billion) lower across the four-year forecast period.

"Although we are still well away from the downside scenario, global economic risks have increased the chances of a downgrade to our revenue forecasts," it said.

But already, one-third of the way through the financial year the operating deficit is bigger, by $NZ1.2 billion or 20% than forecast before last month's election.

Like in Australia, tax revenues are running below forecast. In the case of NZ, the shortfall is around half a billion dollars, or 2.8% under the previous forecast.

And, like our Reserve Bank and the Federal Government, the Kiwi central bank is watching events in Europe like a hawk, and is worried.

"The related declines in international trade and commodity prices, combined with a tightening in global financial conditions, have dampened activity in other regions.

"Notably, many of New Zealand's major trading partners in the Asia-Pacific region have experienced weaker export growth," the central bank said in its monetary policy statement.

"A further slowing in global activity is likely in early 2012 Euro-area activity is expected to contract through 2012 as a result of challenging economic conditions and austerity measures to address elevated sovereign debt levels.

"Some spillover to other regions, including Asia-Pacific economies, is likely. However, the projected downturn in the Asia-Pacific region is modest, consistent with the resilience of domestic demand in the region over recent months

"A period of adjustment in global activity is likely. An overhang of public debt will require large reductions in government spending or increases in taxes in many countries. Furthermore, in many of these same economies there is only limited scope for additional support from monetary policy.

"The deterioration in global economic conditions and the exposure of private European banks to highly indebted sovereigns have resulted in a tightening in international funding markets. These markets are an important source of funding for domestic banks.

"Although New Zealand banks are currently well funded, bank funding costs are likely to increase to some degree over the coming year. This is likely to put some upward pressure on retail interest rates relative to the Official Cash Rate (OCR)."