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Sludge Report #184: When Money Bites

Sludge Report #184: When Money Bites

By C.D. Sludge

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Reserve Bank Governor Alan Bollard explains today's MPS to media.

Listen To The Governor's Press Conference
Press Play To Start Audio Playing….


Ouch. Today's monetary policy announcement from the Reserve Bank makes for some somber reflection. Ugly graphs. Positive outlook. Very difficult decision.

The headlines are
- interest rates are coming down faster than expected - 50 basis points today, more to come;
- the economy is believed to be in a mild recession for the first three quarters of 2008;
- and, that the economy is forecasted to bounce out in the final quarter of calendar 2008.


The graphs are ugly ugly ugly (inflation in particular - and producer price inflation specifically) and the Bank's assessment of the global economic weather ahead is nasty.

While the US economy is not in recession (its banks are being nationalised, housing market is imploding but it is growing) - the global economic outlook has deteriorated faster than expected.

It is perhaps a fairly spectacular reflection on the health of the agricultural export sector, and NZ's Government fiscal health that the bank is plotting what it thinks will be a safe course through the storm ahead.

Dairy returns, tax cuts and interest rate falls are collectively expected to bring us out into the sun on the other side.

And so that is what the Bank is doing, plotting a steady course and hoping for the best. Today's is essentially another steady as we go statement from the Reserve Bank.

The bank is forecasting ongoing official and 90 day interest rate falls - as signaled in July when interest rates were cut for the first time in five years - but this time steeper and faster.

However it is nevertheless also expecting effective mortgage rates to continue to rise for several months more - as a result of the lag between interest rate cuts and the maturity of fixed mortgage replacement.

Notably the Bank's data shows that although fixed rates have started to fall, floating rates offered to new borrowers have continued to rise since July.

The bank describes the effect of this as "contractionary".

What it means is that your wallets are continuing to be squeezed - intentionally - in order to discourage inflation.

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In ordinary circumstances the bank might have been inclined to cut rates much faster than they are given the state of the housing market and the outlook for business investment.

However at present CPI inflation is forecast to peak at 4.8% way outside of the policy target band of 0-3%.

The problem the bank has is that NZ's inflation is fueled by oil and commodity price inflation - as well as massive global producer price inflation - most of which the bank has no control over.

And so this is what happens when money bites. We wait (this winter in Wellington in front of the heater/fire) and read pamphlets about big screen TVs that the bank doesn't want us to start buying, just yet.

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A group of Monetary Policy maestros from Scots College attended this morning's announcement

The bank's calculation is thus this:

- Downside risks of pushing the economy into an unnecessarily large recession are high.
- Downside risks of allowing inflation to get away are also very high.

Therefore the bank has decided for now to wait a bit longer before it actually relieves households from the economic choke hold they are currently in. Hopefully this will dampen our - fairly high - inflationary expectations. Perhaps more directly the shortage of consumer discretionary spending will encourage businesses to keep price rises to a bare minimum.

Interesting in all of this is the manner in which the NZ economy is seen by international markets. The Governor said the bank is not expecting any "stickyness" from banks in terms of lowering interest rates over coming months - mainly because there is a long way for them to fall before they come close to our trading partners.

And so NZ's interest rates are now expected to fall faster than all our major trading partners. According to forecasts around 2% over the coming 2 years (and downward projections tend to be conservative(.

This in turn is expected to create downward pressure on the NZ Dollar. After the announcement this morning the dollar declined 1 full cent to around 65.4 US Cents. As of 11.30am it has not however fallen out of bed and the Reserve Bank's desire for an orderly gradual depreciation in the dollar may still be on the cards.

Listen To The Governor's Press Conference
Press Play To Start Audio Playing….


NOTE: During the press conference (which you can listen to at the above link) somewhat leading questions from this writer concerning New Zealand possibly having a better economic outlook than some of our trading partners - and particularly the US - elicited a fairly skeptical response from the Governor.


Anti©opyright C.D. Sludge 2008

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