A cut to the OCR, why?

Note:  This post is like a personal summary of information from the recent past – given that I have been too slack to write about international events here.  Sorry if it reads like a list 😛

I see that my workplace came out and said that they expect the official cash rate to be cut in June – by 25 basis points to 2.25%.  Unsurprisingly, I agree with the assessment of my colleagues.  However, a large number of other economists – whose views I also have a lot of respect for – believe that a cut is not on the cards, at least not yet.

So why is there a difference, why would a rate cut be justified (or not), and are there red flags to look out for?  Well James Weir answered all these questions in the Dominion Post so I don’t have to 😉

In my mind and in the Dom article, the combination of a persistently high currency (which holds down output and thereby inflationary pressure), low measured inflation, falling commodity prices, a weak labour market, and signs that the recovery in the housing market is not infallible all suggest that the appropriate level of the official cash rate is now lower.

Add to this the RBA’s willingness to cut their cash rate by 50 basis points due to bank funding pressures, the RBNZ’s warning on the OCR, and the fact that monetary conditions have been eased overseas (a primary driver of the relatively higher dollar – the Bank of Japan has been the latest, but lets not forget about the Fed’s willingness to hold rates at low levels until late-14) and I believe (and it seems my workplace does as well) that the “appropriate track” for the official cash rate is now lower, and so the Reserve Bank will be willing to cut to place us on a track that meets its inflation mandate and minimises volatility in the New Zealand economy 😉

It is perfectly reasonable to not agree with this view – and to say that the stimulatory impact of the rebuild in Christchurch and a broader recovery in  the housing and construction markets will see spare capacity get used up, and as a result there is not need to reduce the track for the cash rate.  It is this view that many of the banks are sticking to at present.

Now recent data has seen the market price in an 81% chance of an OCR cut in June, this combined with uncertainty in Europe following the Greek and French elections has seen the dollar fall sharply (the TWI has dropped since the start of last week).  If the currency experiences another sharp downward leg, it reduces the chance of a rate cut – think of it this way a lower currency will stimulate output in New Zealand given current prices, reducing unemployment and the output gap, meaning that the RBNZ needs to do less work to meet their mandate.

UpdateEric Crampton offers comments here.

4 replies
  1. Eric Crampton
    Eric Crampton says:

    Hmm. The Credit Suisse link has the chance of a 25bp drop at 81%. iPredict has “no change” at 71%, after a spike downwards to 60 that was quickly reversed.

    Shame it’s impossible for a retail guy like me to play that arb. 

    • Matt Nolan
      Matt Nolan says:

      The Credit Suisse link is implied market pricing on interest rate markets – so it is interesting to see that two markets that involve trade based on the latest information have such different prices. 

      For now, when it comes to the OCR, I will stick to interest rate markets where the money on the line is a lot more significant.

  2. Eric Crampton
    Eric Crampton says:

    But, more chance of RBNZ insiders trading on iPredict as a bit of fun than their taking big positions on the interest rate markets.

  3. Matthew
    Matthew says:

    This guy agrees – RBNZ should ease


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