RESERVE BANK ANNOUNCES SECOND REDUCTION IN OFFICIAL

UNCLAS SECTION 01 OF 02 WELLINGTON 000296 SENSITIVE SIPDIS STATE FOR EAP/ANP, EEB, INR, STATE PASS TO USTR, PACOM FOR J01E/J2/J233/J5/SJFHQ 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 WELLINGTON 00000296 001.2 OF 002 ¶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