Reserve Bank cuts OCR to record level of 1.75%, But the markets push up the Kiwi dollar value against US dollar

 By -Neethu Khullar

Reserve bank of New Zealand announced to cut the official cash rate (OCR) to a record low 1.75 percent by dropping it 25 basis points  , in an attempt to increase inflation and lower the value of the kiwi dollar.Despite being motivated by a belief from the Reserve Bank that the dollar needs to be weakened, the markets reacted by pushing up the kiwi dollar by around half a cent against the US dollar. The Reserve Bank Governor Graeme Wheeler said the latest cut, along with other policy settings, should see growth strong enough to have inflation settle near the middle of its target range of 1-3 percent.

The Official Cash Rate (OCR) is the interest rate set by the Central  Bank to meet the inflation target specified in the Policy Targets Agreement (PTA).  In simple sense, the Reserve bank of New Zealand trying to reduce the   exchange rate  NZ dollar against US dollar, for boosting the export of Dairy and Meat products.

The Reserve Bank cut its standard rate by 0.25 percent, its seventh quarter-point cut since June 2015. The move was expected by most economists. The bank is estimating that it will keep rates low for several more years.The last time the OCR was cut back in August, most of the banks passed on only a fraction of the cuts on floating rate mortgages, while the interest rates offered on deposits rose.

Bank Governor Graeme Wheeler said that around the globe, economic conditions are weak and interest rates are low, which is putting upward pressure on the kiwi dollar.

New Zealand’s economy is growing vigorously with annual rate of about 3.6 percent. Wheeler said that’s thanks to a growing population as well as strength in the construction and tourism industries.

Wheeler told reporters that ahead of the announcement the Reserve Bank reviewed the decision in light of the surprise victory by Donald Trump, but decided not only that the decision was the right one, that its statement did not need to change.

The kiwi dollar remained stronger than was sustainable, boosted by New Zealand’s relatively strong interest rates.

“Political uncertainty remains heightened and market volatility is elevated,” Wheeler said.

While economists do not generally expect more interest rate cuts, the Reserve Bank’s statement did not rule out more in the future.

“Numerous uncertainties remain, particularly in respect of the international outlook, and policy may need to adjust accordingly,” Wheeler said.

ASB chief economist Nick Tuffley said the bank expected interest rates were likely to remain on hold in the coming months, although another cut was more likely in the near term than any increase.   “Inflation is likely to be back within the 1-3 per cent target band [by the end of 2016].  Dairy prices have recovered considerably.  The labour market is tightening.  Growth is running at an above-trend pace.  It is not an economy that is crying out for urgent stimulus to boost inflation,” Tuffley said.

The nation’s annual inflation rate is 0.4 percent, well below the bank’s target of about 2 percent. The New Zealand dollar is worth about US$0.73, which is higher than exporters would like. The country’s economy depends on exports of dairy products to China.

By lowering interest rates, the reserve bank risks sustaining a runaway housing market.

“House price inflation remains excessive and is posing concerns for financial stability,” Wheeler said

New Zealand’s government had been hoping to enhance exports by signing a trade deal with the U.S. and a number of Asian countries. But Donald Trump has opposed the Trans-Pacific Partnership, and now his President ship may mean the deal is dead.

What the OCR does

The OCR influences the price of borrowing money in New Zealand and provides the Reserve Bank with a means of influencing the level of economic activity and inflation. An OCR is a fairly conventional tool by international standards. In the past, the Reserve Bank used a variety of tools to influence inflation, including influencing the supply of money and signalling desired monetary conditions to the financial markets. Such mechanisms were more indirect, more difficult to understand, and less conventional.

How the OCR works

Most registered banks hold settlement accounts at the Reserve Bank, which are used to settle obligations with each other at the end of the day. For example, if you write out a cheque or make an EFTPOS payment, the money is paid by your bank to the bank of the recipient. Many hundreds of thousands of such transactions are made every day. The Bank pays interest on settlement account balances, and charges interest on overnight borrowing, at rates related to the OCR. These rates are reviewed from time to time, as is the OCR. The most crucial part of the system is the fact that the Reserve Bank sets no limit on the amount of cash it will borrow or lend at rates related to the OCR.