Bollard cuts OCR to 2.5% in hedge against Christchurch quake

Bollard cuts OCR to 2.5% in hedge against Christchurch earthquake impact

By Paul McBeth

March 10 (BusinessDesk) – Reserve Bank Governor Alan Bollard cut the official cash rate half a percentage point to 2.5% in what he termed an “insurance measure” to stave off a severe downturn in the wake of the 6.3 magnitude Christchurch earthquake.

“We have acted pre-emptively in reducing the OCR to lessen the economic impact of the earthquake and to guard against the risk of this impact becoming especially severe,” Bollard told reporters in Wellington. “While it is difficult to know exactly how large or long-lasting these effects will be, it is clear that economic activity, most certainly in Christchurch but also nationwide, will be negatively impacted.”

The statement confirms the widespread anticipation of a cut to stem the blow to economic confidence after last month’s quake, which killed at least 166 people and wreaked some $15 billion worth of damage. About $9 billion of that is assumed to be on residential property, with commercial property and public infrastructure assets costing $3 billion each.

Today’s statement suggests official interest rates will rise steeply next year, as reconstruction takes hold in Christchurch, with economic growth seen peaking at close 6% in 2013. The bank expects the high proportion of floating rate mortgage lending to mean today’s cut will create a swift improvement, while making a reversal quicker in a year or so.

Prime Minister John Key stepped on constitutional niceties last week when he told Bloomberg he expected a rate cut and would welcome such a move, while major lenders have already pre-empted a reduction in the OCR, shaving half a percentage point from their one-year mortgage rates.

Bollard had to weigh up whether the impact of the quake was so great as to warrant a cut that wasn’t focused solely on price targets, and would have the effect of shoring up business confidence. The quake is expected to push up prices as resources are mobilised to rebuild Christchurch, and it would be inappropriate for stimulatory rates during the rebuild, the statement said.

Earlier this week, the Treasury said there were inflationary pressures throughout the global economy, and the Christchurch reconstruction was so large it would inevitably have an impact on inflation. The faster the rebuild, the greater the pressure on prices, it said.

The central bank expects inflation will come back within its target band of between 1% and 3% once the effects of last year’s hike in consumption tax flow through, and forecasts 4.4% growth in the consumer price index in the March 2011 year, slowing to a pace of 2.1% in 2012 and 2.4% in 2013.

The bank offered uncharacteristically limited economic projections in today’s statement as it struggled to come to grips with the size and scope of the quake. “Readers should view the forecasts as a thematic representation of the thinking behind the policy decision, rather than a strict prediction of the future,” it said. Full projections will be included in the June MPS.

Bollard pushed out the expected track of rate hikes even further, having already trimmed the forecast. The 90-day bank rate is expected to be 3% in the 2012 March year, 0.7 percentage points lower than forecast in the December statement.

Traders had been betting he would hike the OCR by 50 basis points over the coming 12 months before the quake, and were expecting the rate to be just 7 points higher in a year’s time before the release, according to the Overnight Index Swap curve.

The move puts New Zealand at odds with other central banks, which are looking at removing the extraordinary stimulus put in place to cope with the collapse of the global financial system in 2008 and tightening monetary policy.

Bollard stopped tightening monetary policy after two increases in the middle of last year as the economic recovery struggled to take hold, with an unexpected contraction in the third quarter and minimal growth in the second.

The quake has made the prospect of a double-dip recession a reality on the central bank forecasts, with annual growth in the March 2011 year trimmed by 0.8 percentage points to 0.9%. Much of that comes from the quake, which will shave 0.6 percentage points from economic growth in the first quarter, in an economy that was already flat-lining.

The Treasury’s expecting economic growth of just 2% this year, down from the 3.5% forecast in the half-year update, but still stronger than the 0.5% predicted by the New Zealand Institute of Economic Research.

Before the disaster, there were signs of the economy was picking itself back up, with sentiment surveys showing increasing numbers of firms optimistic about the future, while Fonterra Cooperative Group hiked its forecast pay-out to farmers on the day of the quake on the back of record high prices for locally produced commodities.

“The earthquake has dealt the economy a serious blow. Limited information to date quantifying the extent of the earthquake damage suggests around 2% will be knocked off national GDP in 2011 leaving growth at only 1.5%, but surging to 5.1% in 2012 during reconstruction,” said Imre Speizer, market strategist at Westpac Banking Corp., in a note before the announcement.

(BusinessDesk)

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