The Reserve Bank of New Zealand (RBNZ) has now cut its rate by 50 basis points this year, following a cut in March, and by 150 points since embarking on an easing cycle in June 2015.
Nevertheless, the New Zealand dollar - known as the kiwi - rose in response to the rate cut, a move that is likely to disappoint the central bank, which was surprisingly blunt in its wish for a weaker exchange rate by saying that "a decline in the exchange rate is needed" as the high exchange rate is making it difficult to meet its inflation objective as it causes deflation in the tradable sector.
"Weak global conditions and low interest rates relative to New Zealand are placing upward pressure on the New Zealand dollar exchange rate," RBNZ Governor Graeme Wheeler said in a statement.
The rate cut comes after the RBNZ in its previous policy decision in June said further easing "may" be required and then on July 20 that further easing was probably needed to lift inflation.
New Zealand's inflation rate was steady at 0.4 percent in the second quarter from the first quarter - well below the RBNZ's target of 2.0 percent, plus/minus 1 percentage point - and Wheeler said inflation was expected to weaken further in the September quarter due to low fuel prices and cuts in Accident Compensation Corporation (ACC) levies.
Inflation is seen rising in the fourth quarter due to the RBNZ's rate cuts, a strong domestic economy, a reduced drag from tradable inflation and rising non-tradable inflation, Wheeler said.
"Although long-term inflation expectations are well-anchored at 2 percent, the sustained weakness in headline inflation risks further declines in inflation expectations," he added.
Supporting its expectation of further rate cuts, the RBNZ in its latest monetary policy statement forecast that the 90-day bank bill rate - indicative of OCR - would drop to 2.1 percent in December this year, then to 2.0 percent in March 2017 and 1.8 percent by June 2017 where it would remain until the end of its forecast horizon in September 2019.
This compares with its forecast from June when it expected the 90-day bill rate to fall to 2.2 percent in December this year and remain at that level in March 2017 before declining to 2.1 percent in June 2017 and remaining at that level through June 2019.
The central bank also lowered its forecast for consumer price inflation to average 1.1 percent in 2017 from June's forecast of 1.5 percent, while it retained the 2016 forecast at 0.4 percent. For 2018 inflation is now seen averaging 1.7 percent, down from 2.1 percent, and then 2.1 percent in 2019, up from the previous forecast of 1.9 percent.
The kiwi began depreciating in July 2014 and fell to a low of almost 1.60 to the U.S. dollar in September last year, a level not seen since 2009.
But since then, it has steadily firmed and was trading at 1.373 to the U.S. dollar today, up from 1.386 before the rate cut for an appreciation of 6.3 percent since the start of this year.
The Reserve Bank of New Zealand issued the following statement by its governor, Graeme Wheeler:
"The Reserve Bank today reduced the Official Cash Rate (OCR) by 25 basis points to 2.0 percent.
Global growth is below trend despite being supported by unprecedented levels of monetary stimulus. Significant surplus capacity remains across many economies and, along with low commodity prices, is suppressing global inflation. Some central banks have eased policy further since the June Monetary Policy Statement, and long-term interest rates are at record lows. The prospects for global growth and commodity prices remain uncertain. Political risks are also heightened.
Weak global conditions and low interest rates relative to New Zealand are placing upward pressure on the New Zealand dollar exchange rate. The trade-weighted exchange rate is significantly higher than assumed in the June Statement. The high exchange rate is adding further pressure to the export and import-competing sectors and, together with low global inflation, is causing negative inflation in the tradables sector. This makes it difficult for the Bank to meet its inflation objective. A decline in the exchange rate is needed.
Domestic growth is expected to remain supported by strong inward migration, construction activity, tourism, and accommodative monetary policy. However, low dairy prices are depressing incomes in the dairy sector and reducing farm spending and investment. High net immigration is supporting strong growth in labour supply and limiting wage pressure.
House price inflation remains excessive and has become more broad-based across the regions, adding to concerns about financial stability. The Bank is consulting on stronger macro-prudential measures that should help to mitigate financial system risks arising from the rapid escalation in house prices.
Headline inflation is being held below the target band by continuing negative tradables inflation. Annual CPI inflation is expected to weaken in the September quarter, reflecting lower fuel prices and cuts in ACC levies. Annual inflation is expected to rise from the December quarter, reflecting the policy stimulus to date, the strength of the domestic economy, reduced drag from tradables inflation, and rising non-tradables inflation. Although long-term inflation expectations are well-anchored at 2 percent, the sustained weakness in headline inflation risks further declines in inflation expectations.
Monetary policy will continue to be accommodative. Our current projections and assumptions indicate that further policy easing will be required to ensure that future inflation settles near the middle of the target range. We will continue to watch closely the emerging economic data."
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