UPDATED- Bollard faces further pressure to cut OCR

The Reserve Bank should cut the official cash rate by 50 basis points to kick-start activity in the wake of the Christchurch earthquake, Moody’s Analytics says.

But HSBC doesn't expect a cut to the OCR, which it says will likely remain on hold until the fourth quarter of this year.

The Moody's report, by Sydney-based associate economist Katrina Ell, said a promise by the Reserve Bank to keep interest rates on hold for an extended period won’t be enough to get the recovery going.

Instead, commercial banks need to see a “concrete commitment” to maintain stimulatory policy settings before mortgage rates will be lowered substantially.

“With the nation’s economy on the brink of slipping back into recession, a promise from the Reserve Bank  to hold rates steady for an extended period won’t be enough to restore confidence in the wake of February’s devastating earthquake.

“The central bank needs to cut the official cash rate by 50 basis points this week to kick-start activity.”

Action by the Reserve Bank would have a “corollary benefit” of enhancing the monetary policy transmission mechanism, the report says.

“Historically, the majority of Kiwi households have opted for fixed-rate mortgages, meaning changes in the cash rate take considerably longer to flow through to home loan rates and stimulate the economy.

“Since September, however, more than half of all new mortgages have been on floating rates.

“A rate cut now would provide a powerful incentive for more prospective borrowers to opt for the currently considerably lower variable-rate mortgage, a shift that would make monetary policy a more potent tool for managing the macroeconomy.” 

But HSBC chief economist (Australia and New Zealand) Paul Bloxham sees things differently, saying “in our view, the case for an OCR cut is not clear.”

A fiscal policy response is more appropriate, he said, pointing to the risk that an OCR cut could stoke already rising inflation.

“Globally inflation is building, oil prices rising, and a rate-cut driven New Zealand dollar depreciation could see higher domestic inflation at a time when headline inflation is well above the Reserve Bank’s comfort zone due to tax changes.”

The Reserve Bank’s Policy Targets Agreement explicitly mandates looking through the effects of natural disasters, he said.

Instead of cutting the OCR, the Reserve Bank could just announce it would keep it at the current rate of 3.00% for some time.

If it does cut the rate, “it would seem that the Reserve BVank has judged that it expects to see a larger reduction in demand – due to reduced confidence – than the reduction in supply due to the earthquake, in which case cutting interest rates may be the right strategy (once the effects of various fiscal programmes are accounted for).”