Roger J Kerr bemoans the unwillingness of the Reserve Bank to catch out the markets with an unexpected rate cut

By Roger J Kerr

Would a surprise RBNZ cut to the OCR of 25 or 50 basis points next week really run the risk of fuelling the white-hot housing market even more with lower mortgage rates?

Worries about the housing market and financial stability implications still appear to be the reason why the RBNZ are reluctant and hesitant OCR cutters.

The balance of risks and rewards to the economy by surprising the markets with an aggressive rate cut need to be carefully assessed. However, the advantages of getting the currency lower and inflation back within the allowable 1% to 3% band seem to outweigh housing market risks at this point, in my view.

The changed LVR rules now in place should remove some of the housing market heat. The question is whether bank funding and lending interest rates will actually change following a lower official OCR interest rate to 1.75% or 1.50%?

Very little of the 11 August 0.25% OCR cut to 2.00% was passed through into lower bank lending interest rates as the banks do not fund their books from the OCR. They largely fund from retail deposit interest rates and these rates have held firm and have actually increased in some cases.

Credit margins in offshore wholesale debt markets have also increased for the banks. Some of the NZ banks are starting to struggle with their funding books as APRA regulatory rules in Australia require the repayment of Aussie parent bank loans.

Credit growth in the economy may remain strong. However, if the banks are becoming much tighter in their funding of that growth, the price of money goes up, not down (as demand exceeds supply).

It’s very hard to see the banks reducing their lending rates in this environment, no matter what the OCR is doing.

The current position of the banks’ funding books has reduced the risk that an OCR cut will add fuel to the residential property market fire.

So far this year the RBNZ have been slow, measured, cautious and very predictable with OCR interest rate reductions.

The result has been offshore speculators seeing the Kiwi dollar as a safe bet – and the Trade Weighted Index has moved higher after nearly all the RBNZ statements/decisions.

To get traction with a lower exchange rate the RBNZ need a game changer to their past approach. They have to make decisions and take action that the markets do not expect.

The interest rate markets are pricing a 0% probability of an OCR cut next week, therefore here is the opportunity for the RBNZ to take a leaf from the RBA’s playbook and surprise the markets with an OCR cut.

If the US Federal Reserve also surprise the markets with an interest rate hike the day before the RBNZ review next week we will get a double whammy negative impact on the Kiwi dollar. Governor Wheeler needs the hedge fund speculative boys to get on his side by shorting the Kiwi dollar. However, he must first provide them with a reason to sell.

The aforementioned strategy and market window of opportunity is available to the RBNZ.

Will they take it?

It’s unlikely, judging be past decisions and actions. When our manufacturing and food exporters selling in Aussie dollars start to lay off workers as they are unprofitable with a 0.9700 NZD/AUD cross-rate, the penny may drop at the RBNZ.

Daily swap rates

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Roger J Kerr contracts to PwC in the treasury advisory area. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com