NEW ZEALAND SLASHES KEY INTEREST RATE

UNCLAS SECTION 01 OF 02 WELLINGTON 000404 SIPDIS STATE FOR EAP/ANP, EAP/EP AND EEB, STATE PASS TO USTR, PACOM FOR J01E/J2/J233/J5/SJFHQ E.O. 12958: N/A TAGS: ECON ETRD EFIN APEC PGOV PREL NZ SUBJECT: NEW ZEALAND SLASHES KEY INTEREST RATE Ref: Wellington 357 WELLINGTON 00000404 001.2 OF 002 ¶1. (U) Summary: On December 4, New Zealand's Reserve Bank (RBNZ) lowered the official interest rate from 6.5 percent to 5 percent, paralleling a move by Australia earlier in the week. The 1.5 percent reduction brings the rate to its lowest level for the past five years marking a 3.25 percent cumulative reduction since July ¶2008. Although the annual inflation rate hit 5.1 percent in September, the RBNZ expects year-on-year inflation to fall back to within the target band of 1 to 3 percent by mid-2009. While generally satisfied with the Bank's action today, the business community remains cautious noting that the benefits of the rate reduction will not be immediately felt in certain key sectors like the real estate market. Some are predicting the OCR to bottom out at 3.25 percent around the middle of next year. End Summary. RBNZ slashes Official Interest Rate -------------- ¶2. (U) On December 4, New Zealand's Reserve Bank (RBNZ) lowered the official interest rate (Official Cash Rate - OCR) from 6.5 percent to 5 percent. The 1.5 percent reduction, the largest since the OCR was established in 1999, brings New Zealand's OCR to its lowest level in the past five years. This leaves the OCR close to the Australian rate of 4.25 percent, a crucial fact for New Zealand businesses operating in these two closely linked economies. Reserve Bank Governor, Dr. Alan Bollard said ongoing financial market turmoil and a marked deterioration in the outlook for global growth played a significant role in today's decision. He noted that economic activity with New Zealand's trading partners is expected to contract or grow slowly over the next few quarters which in turn has caused economic activity within New Zealand to be constrained more than anticipated since the last rate cut in October (see Reftel). ¶3. (U) RBNZ's action today marks a 3.25 percent cumulative reduction in the OCR since July 2008 with the Bank hoping its expansionary monetary policy, together with the depreciation in the Kiwi dollar (trading today at US 0.53c down from a high of US 0.80c) will provide the needed stimulus for domestic demand and create the conditions for a rebound in growth as global conditions improve. (Note: The newly elected National led government will open the next Parliament on December 8 and is expected to announce the details of its fiscal stimulus package which is expected to include additional tax cuts meant to complement the actions taken today by the RBNZ. End Note.). ¶4. (U) Although the annual inflation rate hit 5.1 percent in the September '08 quarter, due largely to high gas, utility rates and food prices, Dr. Bollard expects year-on-year inflation to fall back to within the Bank's target band of 1 to 3 percent by mid-2009. Bollard said, "...(because) growth had been weaker than projected in October, inflationary pressure has subsided and GDP is now projected to trough at negative 0.2 percent in the middle of 2009 then expected to rise to 1.3 percent in 2010." Meanwhile, unemployment is expected to peak at 6 percent by the end of 2009),marking a dramatic rise from a low of 3.3 percent in 2007 although expected to be lower than during previous downturns (for example 10.4 percent in 1992). Not Enough for Business Community -------------- ¶5. (U) A variety of commentators from the business community have begun to react to today's record cut in the OCR. JPMorgan economist Helen Kevans is forecasting inflation to fall below the Reserve Bank's target range of 1-3 percent before the end of next year, which points to the need for still more assertive stimulus. "GDP will decline for 'at least' another three quarters says Ms Kevans, before rebounding from just 0.3 percent in 2009 to 2.8 percent in ¶2010. JPMorgan expects the OCR to bottom out at 3.25 percent around the middle of next year. ¶6. (U) Bayleys' (large commercial real estate firm) managing director, Mike Bayley, says it could be some time before the full effects of the decrease flow through to the property sector, because more than 80% of New Zealand home mortgages are on fixed terms. "Interest repayment levels are just one consideration in the decision-making process involved with buying residential property - alongside such other factors as genera economic confidence, household debt levels, business forecasts and job security," says Mr Bayley. "Lowering the OCR is certainly the first step in redressing WELLINGTON 00000404 002.2 OF 002 what has been a declining property market in both sales volume and prices throughout 2008, however these other factors, along with raising immigration levels, need to be stabilized before we will see any major correction in property prices." Expect More Cuts -------------- ¶7. (U) The RBNZ is leaving the door open to further reduction in the OCR. The Bank's Monetary Policy Statement (MPS) predicts that "further movements in the OCR will be assessed against emerging developments in the global and domestic economies and the responses to policy changes already in place." MCCORMICK