15 Jul 2016

Is an interest rate cut on the cards?

9:09 am on 15 July 2016

Surprise moves from central banks in New Zealand and Britain have raised expectations of interest rate cuts next month.

Reserve Bank of New Zealand

Reserve Bank of New Zealand Photo: RNZ / Alexander Robertson

The Reserve Bank of New Zealand has said it will issue an economic update next week because of the longer than usual gap between its monetary statements as it changes its timetable for decisions.

"This will not include an Official Cash Rate (OCR) review decision," the RBNZ was quick to point out.

But the fact the central bank felt moved to "update" its economic assessment was enough to unsettle investors, cause a near on cent fall in the New Zealand dollar, and raise the odds of a rate cut at its scheduled 11 August statement.

"We doubt (it) would be occurring if the economic and inflation outlook had not changed markedly since the June MPS," said Deutsche Bank chief economist Darren Gibbs.

He said the strength of the New Zealand dollar, which has risen more than 4 percent against a basket of currencies since the RBNZ's statement in June, would be worrying the central bank and next week's statement will give an opportunity to "jawbone" it lower.

"We think it is more than likely that the exchange rate will be described as unjustified and unsustainable, and a significant drag on the inflation outlook... we think it would be hard for the RBNZ not to deliver the further OCR cut it first signalled in the March MPS."

The RBNZ has been warning for some time that inflation, which has been outside its target band for more than a year, has been too low and it would lower interest rates to counter the deflationary pressure.

After the RBNZ's statement financial markets increased the odds of a rate cut next month to around 50 percent, from around 30 percent.

Although it has been made it clear there will be no comment on the cash rate next week, but the reaction has been that the odds of a rate cut are now put at 50-50 from the previous one in three.

Meanwhile, the Bank of England also surprised overnight by opting to hold its benchmark interest rate steady, but signalled a rate cut could be as close as three weeks away.

The Bank's monetary policy committee voted eight to one to keep rates on hold at 0.5 percent, which surprised many investors who regarded a cut as almost a foregone conclusion following Britain's shock vote on 23 June to leave the European Union.

The no-change decision sent the British pound surging; it gained more than 1.4 percent against the US dollar, and the New Zealand dollar slipped to 54 British pence at 7.45am from 55.4 pence the day before.

The Bank of England acknowledged that business and consumer confidence has fallen in the wake of the Brexit vote, but said unless the economic situation improved over the next month "most members of the committee expect monetary policy to be loosened in August."

Analysts said the need for a rate cut was not so pressing because of the rapid political developments that have resulted in Theresa May becoming Britain's Prime Minister and her appointment of a new government.

"Not acting now allows the BoE to keep its powder dry and wait for more data to become available" said John Thanassoulis, a Professor of Financial Economics at the Warwick Business School.

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