NZIER 'Shadow Board' warns Reserve Bank against cutting interest rates too hard

The Reserve Bank’s getting a warning about being overly aggressive on easing monetary policy ahead of its decision tomorrow on whether to further cut official interest rates.

The New Zealand Institute of Economic Research’s ‘Shadow Board’, comprising of prominent economists, academics and business people, is expecting that the Official Cash Rate (OCR) will be trimmed to 3% from 3.25%.

The OCR was cut to the current level just last month from 3.5% previously in response to a slowing economy and rapidly deteriorating terms of trade – the latter largely due to a big slump in dairy prices.

However, while the views of the nine-strong ‘board’ have moved very strongly in the past month in terms of expecting lower interest rates, they are cautioning the RBNZ on going too far too fast.

“While there is some support for a 0.5% cut or more, this is not a majority view,” NZIER senior economist Christina Leung said.

Shadow board member Arthur Grimes, an academic who in the recent past has been chairman of the RBNZ, said the world economy was shakier now than it was six weeks ago when the RBNZ was last making a call on interest rates. He pointed specifically to China, Australia and Greece. “…So a further cut in the OCR is warranted. However, the lower exchange rate and likely accompanying rise in inflation caution against being too aggressive in cutting rates.”

Fellow shadow board member and BNZ head of research Stephen Toplis said there were “huge risks” to the current economic and inflation outlook.

“If dairy prices don’t recover and drought hits we could be headed for recession and much lower rates. But if the currency keeps falling, much higher headline inflation will pose a significant challenge for the RBNZ suggesting significant upside pressure for rates even as the economy softens.”

In making a decision on where the OCR should be shadow board participants share out 100 points across possible interest rates to indicate what they believe is the most appropriate Official Cash Rate setting for the economy. Combined, these scores form a shadow board view ahead of each monetary policy decision.

NZIER’s Leung said the shadow board’s average recommended interest rate of 3% now compared with an average reading of 3.4% in June.

The RBNZ’s decision to cut in June did come as a mild surprise to the markets as the majority of economists had expected that it would wait till later in the year before cutting.

Since the cut by the RBNZ last month the views of, particularly the economists, on the shadow board have moved very firmly toward lower interest rates.

A majority of economists are now picking that the Reserve Bank will completely unwind the one-percentage point hike in interest rates last year, bringing the OCR back to 2.5% by the end of the year. Westpac economists are now even picking a 2% OCR by the end of the year.