Banks rush to cut rates following RB announcement

Reserve Bank governor Don Brash confirmed most economists’ expectations by cutting the official cash rate by 25 basis points to 5.75% this morning in his third such move this year.

Within minutes of the cut being announced mortgage interest rates started falling. WestpacTrust cut its floating home loan rate by 25 points to 7.7%.

The move came less than three hours after the US Federal Reserve also met expectations and cut its benchmark rate, the federal funds rate, by 50 points to 4%, its lowest level in seven years. It is the Fed’s fifth such move this year and it promised more of the same if it fails to combat ``excessive weakness’’ in the US economy.

Both Brash’s action and comments were far more cautious, although he stopped short this time of warning the market not to expect another cut soon. He even hinted that the next move in interest rates could be upwards.

Reaction in the wholesale market was reasonably cautious, the 90-day bank bill yield easing from 5.84% late yesterday to 5.74%. When Brash last cut rates on 19 April, the wholesale market immediately anticipated a further cut.

The decision to cut ``reflects the balance of tensions between contradictory influences on the future path of inflation in New Zealand,’’ Brash says.

The economies of many of our major trading partners, particularly Australia, the US, Japan and the rest of Asia, have grown slowly in recent months and in New Zealand business and consumer confidence has fallen and investment spending slowed, he says.

"There is no sign of any widespread increase in asset prices, with the exception of the prices of some rural land, and growth in money and credit remains relatively weak." As well drought may reduce next season’s agricultural production, "tempering growth in income and spending in the rural economy."

But other indicators of inflation are pointing in the other direction, Brash says.

Prices of some of New Zealand’s major commodities have been particularly strong despite the weakness in our trading partners’ economies and in any case that global weakness is expected to reverse next year.

"In addition, the low exchange rate is providing useful insulation against the slowing world economy. Unemployment is currently near 13-year lows, with many reports of employers having difficulty finding staff. Similarly, some measures of capacity utilisation suggest little scope to increase output substantially without an increase in inflation," he says.

If events unfold as the Reserve Bank expects, inflation should settle back to near the middle of its zero to 3% target range with interest rate settings close to where they are now, Brash says.

But other easily envisaged outcomes could be less benign in either direction "which would require more vigorous monetary policy responses. Thus it is prudent to adjust policy cautiously, as we observe the evolving balance of those influences."

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