Markets uncertain around cash rate cut

MEDIA RELEASE, OMFinancial

9 March 2011

Markets uncertain around cash rate cut

A significant proportion of money market insiders are expecting Reserve Bank Governor Alan Bollard to leave the official cash rate alone tomorrow, according to OMFinancial’s Head of Financial Markets, Kevin O’Sullivan.

This is despite the fact that the major banks have already cut their own interest rates in anticipation of a cut in the OCR of between 25 basis points and 50 basis points.

“It’s important to remember that only a very small proportion of people in the market are able to stake out a position in the way the big banks and institutions can,” says Mr O’Sullivan.

“From talking to interest rate traders here and overseas, it’s clear there is no real consensus around what the RBNZ should do with the OCR – or what it will do.”

Mr O’Sullivan says the argument in favour of leaving the cash rate alone is a straightforward one.

“Under the current Policy Targets agreed between the Reserve Bank and the Government, the Bank is required to set policy that will keep inflation between one and three percent over the medium term.

“With the Consumer Price Index for the three months to December 2010 up four percent, commodity prices continuing to climb, and European Central Bank president Jean-Claude Trichet foreshadowing higher ECB interest rates as early as next month, a lot of people in the market are questioning whether now is the right time for a rate cut.”

Mr O’Sullivan says Prime Minister John Key’s pro rate cut comments will have added political pressure to Governor Bollard’s list of considerations, but doubts they will have any effect on tomorrow’s decision.

“In January 2010, the market was hell bent on pricing in rate hikes, but Bollard held his ground. The ensuing brutal rally in the futures markets hit traders squarely in the bottom line, and sent the market a clear message that Bollard would not be bullied.”

If the Governor does decide to cut the OCR, market expectation is it will be by 50 basis points, Mr O’Sullivan says.

“The feeling is that 25 points would not be enough to have any significant effect. Furthermore, Bollard would run the risk of appearing to have bowed to political pressure by making the minimum reduction.

“And while a cut of more than 50 basis points does have some support, it would be uncharacteristically aggressive – and take the OCR down below what Bollard has previously described as ‘emergency levels’,” says Mr O’Sullivan.

Mr O’Sullivan says he expects inflationary pressures will make any cut short-lived.

“Personally, if the rate does drop, I will be looking to hedge against future rate hikes. I believe when our rates start heading north they will do so very quickly, and if I was an exporter to Australia I would look to take full advantage of the current exchange rate.”

ends

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