Cablegate: Reserve Bank Announces Second Reduction in Official

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E.O. 12958: N/A
TAGS: ECON EFIN ETRD PGOV PREL NZ
SUBJECT: RESERVE BANK ANNOUNCES SECOND REDUCTION IN OFFICIAL
INTEREST RATE TO OVERCOME FEARS OF RECESSION

Ref: WELLINGTON 230

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1. (U) Summary. New Zealand's Reserve Bank Governor Alan Bollard
aggressively slashed the prime interest rate from 8 percent to 7.5
percent, leaving some economists surprised expecting only a 25-basis
point move. The unexpectedly large cut caused the New Zealand
dollar to slide about US1.5c to just above US65c, providing more
relief to exporters, with business groups welcoming the lower
interest rates. The Reserve Bank's biggest rate cut since 2001 was
aimed at getting the banks to cut lending rates anticipating a
25-basis-point cut may have been offset by banks to cover higher
international costs because of the ongoing world credit crisis. End
Summary

Interest Rates Cut Again
------------------------

2. (U) On September 11, the Reserve Bank of New Zealand (RBNZ)
announced that it was reducing the prime interest rate ("Official
Cash Rate" -- OCR) by 50 basis points from 8.0 percent to 7.5
percent. In the RBNZ's monetary policy statement (MPS), the Bank
indicated that New Zealand's GDP was likely to have contracted in
each of the first three quarters of 2008, and likely fell by a total
of 0.8 percent over the preceding nine-month period. The reduction
in the OCR marks the second time this year that New Zealand's
Reserve Bank Governor Alan Bollard has delivered a substantial cut
(see reftel). Despite the RBNZ's move, commercial banks have been
slow in passing on the benefit of cheaper loans to homeowners hoping
to restore profit margins.

3. (U) Reserve Bank Governor Alan Bollard explained his rationale
for the making the dramatic cut, saying "the New Zealand economy is
experiencing a marked slowdown, led primarily by the household
sector (housing market) and the outlook for the global economy has
deteriorated further in the wake of continued financial market
turmoil." In addition he went on to say, "the New Zealand business
sector is coming under pressure from both rising costs and falling
demand while domestic activity is likely to pick up later this year
as a result of personal tax cuts, increased government spending and
rising rural (agricultural sector) incomes, we expect a prolonged
period of household sector adjustment and below-average growth."

4. (U) Recent economic indicators in NZ have trended negative,
including rising unemployment (although comparatively low at 3.6
percent), sharply falling construction activity, plunging retail
sales and sagging house prices (down 4.4 per cent in the past year
according to Quotable Value figures - NZ's largest property
information company). Local economists believe the economy has
slowed sharply because the New Zealand public has been battling high
mortgage rates, rising food bills and soaring fuel prices.
Inflation hit an annual rate of 4 per cent, which is outside the
RBNZ's targeted 1 percent to 3 percent range. (Note: The official
second quarter GDP data compiled by Statistics NZ which was expected
in early July will be released at the end of September in order to
dampen talk of recession. End note).

5. (U) The RBNZ is projecting annual average Gross Domestic Product
(GDP) growth to contract by 0.3 percent through early 2009 -- the
weakest since the recession of the late 1990s -- then rise 2.9
percent by 2011. This contraction is deeper than had been expected
in the June MPS, with the pick-up in growth expected to be more
robust than previous MPS predictions. Per September's MPS, with the
extended period of weak economic growth through the remainder of the
year, firms expect a sizeable build-up of excess capacity to result,
making it hard for companies, particularly retailers, to pass on
increased costs to their customers.

Commercial Banks have been Slow to Pass on Rate Cuts
--------------------------------------------- -------

6. (SBU) Despite the earlier move on the part of the RBNZ,
commercial banks have proved extremely slow in passing on the
benefit of cheaper domestic money to homeowners. Mortgage rates
have barely moved and the difference between what it costs the banks
to borrow and the interest rate they charge consumers has widened as
much as 200 basis points in many instances. Only 18 months ago, the
difference was 70 basis points. The commercial banks attribute the
spread to the fact that they need to borrow significant amounts

WELLINGTON 00000296 002.2 OF 002

offshore and New Zealand is charged a risk premium, which has
ballooned in recent months. According to local analysts, domestic
borrowing should be cheaper; "swap rates" (the cost to the banks for
fixed rate lending) has fallen and will fall further with the move
by the RBNZ meaning mortgage rates should follow. The conclusion
these analysts draw is that the banks are restoring profit margins
hit by the credit crisis by continuing to charge unreasonably high
interest rates to home owners. Given the Reserve Bank's recent OCR
cut, the pressure will mount on commercial banks to begin reducing
mortgage rates.

7. (U) The Reserve Bank is forecasting house prices to fall to 10
percent this year and overall 15 percent from their peak last year.
"The market is only halfway through that bust," said Bollard. The
Reserve Bank's bigger rate cut was aimed at getting the banks to cut
lending rates because a 25-basis-point cut may have been offset by
higher international costs because of the world credit crisis.
However, the commercial banks cuts on September 11 to floating
mortgage rates would not immediately help overall household budgets
much because only about 12 percent of loans were on floating rates.
Only a third of fixed loans come up for renewal in the next year,
with an average mortgage interest rate of 8.2 percent, so in the
near term consumers will face higher costs, not lower rates. The
real relief for household budgets should come from lower petrol
prices and tax cuts due next month. Lower lending rates would not
rescue the housing market from its present bust.

Comment
-------

8. (SBU) According to local economic analysts, the RBNZ is now
following a much riskier monetary strategy than in June, when the
Bank had been expected to cut rates and then pause to gauge effects
on inflation and wage rises. Because fears of recession have
worsened (and the Labour Government is heading into an election)
economists believe Bollard is "swinging a big bat to get traction on
(lower) mortgage rates. Some anticipate that another 50-point cut
next month would not be surprising.

MCCORMICK

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