Interest Rates

Tuesday 19 August, 2008

In the absence of any major data releases there has been practically no movement in wholesale interest rates over the past week and even the fall of the Kiwi dollar which for a while became quite rapid yesterday has not had much impact. If there was going to be some impact it would have been the market pulling back on expectations that the Reserve Bank would cut interest rates at each six weekly review over the next few months. The Reserve Bank have explicitly noted that they intend cutting interest rates unless there is “excessive” depreciation in the Kiwi dollar. At the moment the trade weighted index is close to 65 compared with 67.5 a month ago, the same two months ago, and 68 three months ago.

The decline in the Kiwi dollar has so far been relatively mild and has only looked exciting for a while because the cyclical weakness has combined over the past few weeks with a rebound in the greenback. Looking forward our expectation remains that the Reserve Bank will be cutting interest rates by 0.25% at each of the official cash rate reviews in the next year leading to a cyclical low for the rate somewhere between 5.5% and 6.5% toward the end of 2009.

That is, we see the cash rate being taken back to somewhere very close to the probable neutral level. At this stage we don't believe the Reserve Bank is likely to be aggressively cutting the cash rate this cycle to actively stimulate the economy and generate more inflation. Our economy still remains fundamentally short of resources and the easing we can see at the moment is merely cyclical - not structural.

The yield on 90 day bank bills has ended unchanged from a week ago near 8.25%, while the benchmark two year swap rate has ended near 7.34% from 7.3%.

Key Forecasts

• Monetary policy easing with the official cash rate near 6% come late 2009.
• The two year fixed housing rate falling below 8.50% at a stretch late 2008, hitting the five year average of 7.8% in mid-2009 optimistically, but going lower will require weaker data on the NZ economy and decent easing of global credit tensions – possible late in 2009. Falling to the 6.5% low of 1999, 2001 and 2003 is very unlikely this cycle.

If I Were a Borrower What Would I Do?
I would still fix one year.

Source: Tony Alexander, Chief Economist of the Bank of New Zealand.