The Reserve Bank of New Zealand's decision to lower interest rates by 50bp sent the New Zealand dollar tumbling against all of the major currencies. By cutting interest rates more than the market had anticipated, the RBNZ showed just how concerned they must be about the current state of the economy and the impact of the earthquake. One natural disaster is bad, but two quakes within 5 months was too much for any economy, let alone a tiny one like New Zealand to handle. As a result, the RBNZ felt that they had no choice but to lower rates for the first time in nearly 2 years - but what really the kiwi was the size of the rate cut.
As we pointed out in our RBNZ preview, the New Zealand economy was weak before the Feb earthquake and since then business and consumer confidence has suffered. The rate cut, according to RBNZ Governor Bollard will serve to "lesson the economic impact of the quake" but growth will still be quite weak for the first half of this year. New Zealand's economy contracted in the third quarter and based upon previous comments from the Finance Minister, there is a good chance that it contracted in the fourth quarter as well. Although Bollard said that Q4 GDP was roughly flat which means that even if growth contracted, it would be by a nominal amount, he also warned that GDP could contract in Q1, which would be 3 back to back quarters of negative growth. Rebuilding efforts are expected to contribute positively to growth but "it will take time to materialize." The central bank's bold rate move combined with their pessimistic tone indicates that they are more worried about growth than inflation and that their decision was focused on preventing a technical recession from becoming a real one.
Going into the monetary policy announcement, there were valid reasons for the RBNZ to raise interest rates and to keep them on hold. The primary argument against a rate cut was inflation which is still a serious threat. By saying that their forecasts could be affected by oil prices and that rates could rise once the rebuilding efforts are underway, Bollard has effectively signaled that this is a one-off move. Rather than lowering interest rates two months in a row, the central bank has opted for a nuclear move that would leave them room to raise interest rates quickly without posing a major threat to the economy should inflation pressures continue to rise. The RBNZ's mandate is to maintain an inflation rate between 1 and 3 percent and the latest CPI report showed consumer prices growing by an annualized pace of 4.0 percent. By lowering interest rates when oil prices are above $100 a barrel, the RBNZ risks pushing CPI growth even higher. Nonetheless the larger than anticipated move by the RBNZ should lead to additional weakness in the New Zealand dollar.