Flash Notes:RBNZ Cuts; Further Easing Expected Ahead

The Reserve Bank of New Zealand (RBNZ) slashed its cash rate by 25bp earlier this morning to 3.25%. This was the firstrate cut since January 2011 and reverses a period of rate hikes that the central bank engaged in 2014. The accompanyingstatement noted that “a reduction in the OCR is appropriate given low inflationary pressures and the expected weakeningin demand, and to ensure that medium term inflation converges towards the middle of the target range. We expect furthereasing may be appropriate”.

    Whilst the timing of the rate cut may have come by surprise, the RBNZ justified today’s cut by saying that the unexpectedworsening in the terms of trade (the ratio of export prices to import prices) largely triggered by the decline in dairy pricesmeans that “monetary policy needs to be more stimulatory to encourage the pickup in inflation”. That said, the central banknow forecasts CPI inflation to get back to 1.9% (near its 2 percent target mandate) by H2 2016 (their forecasts were not seengetting back to the target in the forecast horizon back in the March 2015 official statement). And alongside the projectedcurrency decline, the central bank said inflation should accelerate.

    The new economic forecasts were also fairly optimistic. The RBNZ now sees average annual GDP growth on the expendituremeasure to accelerate from 3.2% in the year to this March to 3.5% in the year to March next year, down from the 3.6% theRBNZ forecast three months ago. At the same time, whilst the forecast for where the unemployment rate will be in Marchnext year has been revised up, from 4.9% to 5.3%, it is still expected to decline from the current rate of 5.8%.

    More importantly, the RBNZ provided a very strong hint that today’s rate cut will not be a one-off. RBNZ Governor GraemeWheeler also went on to say that significant further downward pressure for the Kiwi is justified. This saw the NZD/USD pairplunging to lows of 0.7016 (from Wednesday’s highs of 0.7232) and New Zealand government bond yields declining acrossthe board. We are expecting another cut in the cash rate by 25bps to 3.0% later in the year, probably in Q4 2015.