As expected, the reserve bank cut their Official Cash Rate by 25 basis points to three per cent last week.
Peter Nicholl
This decision was reasonable. Both the Bank of England the the Reserve Bank of Australia had reduced their official interest rates by 25 points just a few days earlier.
What worries me is what was said in the bank’s accompanying statement. Their statement was described as ‘more dovish than expected’ with a strong indication that the bank was likely to make two more 25 basis points cuts before the end of the year, taking the Official Cash Rate to 2.5 per cent.
Though some other central banks are also reducing their official interest rates, the Bank of England’s official rate is currently four per cent and the Reserve Bank of Australia is at 3.6 per cent. The Unitied States Federal Bank has kept its official rate at 4.25-4.5 per cent all year despite pressure from Trump to lower it. So New Zealand, at three per cent is already significantly lower than most other countries.
The first time the reserve bank took the cash rate as low as 2.5 per cent was in response to the global financial crisis in 2009. Unfortunately, it did not increase the rate after the global financial crisis was over. It mainly stayed within the range 1.75-2.25 per cent from 2012-2020 – and then Covid came along. In response, the bank reduced the rate into uncharted low territory, taking the official cash rate down to 0.25 per cent.
The inevitable happened. The incredibly low interest rates quickly led to a surge in asset prices.
The value of the average house in New Zealand rose by around 40 per cent from 2020 to 2022. The low interest rates also led (more slowly) to a general increase in inflation, not just in New Zealand but everywhere.
The reserve bank eventually had to put the cash rate into reverse and raised it from 0.25 per cent in 2022 to 5.5 per cent in 2023.
Over the past year, it has reversed the direction of the rate again and they have reduced it by 2.5 per cent and it is now down to theee per cent. With inflation currently at 2.7 per cent, this level is barely positive in real terms. Mortgage rates, other borrowing rates and deposit rates have all followed the cash rate down. Despite this, the media keep referring to current interest rates as ‘high’.
They are only high in relation to the incredibly low interest rates that the Covid pandemic induced. Those rates were very abnormal. They were induced by a pandemic of unpredictable dimensions. But they are being treated by many New Zealanders as the new ‘normal’ – the level interest rates should return to. That would be a disaster. I worry that there may be some in our reserve bank who are also thinking this way.
The period 2000 – 2010 is a more ‘normal’ period. During that period inflation was almost always within the RBNZ’s target range of 1-3% and the OCR was was within the range of 4.5% to 6%. The current OCR level of 3% is already well below where it was during that decade of moderate inflation.
What the RBNZ has done in the last nine months is appropriate. But if they keep pushing the OCR down another cycle of low interest rates causing asset price surges and rising general inflation is inevitable. The RBNZ needs to know when it has done enough and wait for the impact of what it has already done to work its way through the financial system.
