(Aug 14): New Zealand’s central bank cut interest rates, embarking on an easing cycle much sooner than previously indicated as the economy slumps and inflation slows. The local dollar plunged.

The Reserve Bank of New Zealand’s (RBNZ) Monetary Policy Committee lowered the official cash rate (OCR) by a quarter percentage point to 5.25% on Wednesday in Wellington. Nine of 23 economists in a Bloomberg survey anticipated the move, while 14 expected no change. The RBNZ’s new forecasts show the OCR falling further in the fourth quarter and by about 100 basis points by the middle of next year.

“We are confident that inflation is back within its target band and we can commence our renormalisation of policy interest rates,” governor Adrian Orr said at a news conference. “It’s been about building the committee’s confidence to get moving, and we’re at that point now.”

The RBNZ’s pivot to easing is a rapid change of tune after it said in May it considered raising rates and wouldn’t cut them until the second half of 2025. The bank’s concerns over sticky domestic inflation are being alleviated as the economy teeters on the brink of its third recession in less than two years and unemployment rises.

The New Zealand dollar dropped after the decision, buying 60.05 US cents at 4.55pm in Wellington from 60.70 cents beforehand, and bond yields fell. Stocks rallied, with the benchmark S&P/NZX 50 Index closing 2.1% higher.

Investors had priced a 67% chance that the RBNZ would cut rates on Wednesday.

Orr said the bank considered a 50-point reduction before settling on a 25-point cut as a reasonably low-risk start to the easing cycle. Future cuts would be data-dependent, and the RBNZ was “in a strong position to move calmly”, he said.

Another recession

The RBNZ’s updated forecast track for the OCR “is consistent with 25-basis-point cuts in each of the next three meetings and a slower pace thereafter down to 3%”, said Sharon Zollner, the chief New Zealand economist of ANZ Bank in Auckland.

The RBNZ adopted a less hawkish tone in its July review, when it said tight policy might be curbing demand more strongly than expected. On Wednesday, it forecast contractions in the second and third quarters of this year, which would be the country’s third recession since the end of 2022.

“The committee noted that the weakening in domestic economic activity observed in the July monetary policy review has become more pronounced and broad-based,” the RBNZ said. “With a broad range of indicators suggesting the economy is contracting faster than anticipated, the downside risks to output and employment that were highlighted in July have become more apparent.”

Investors have ramped up bets on central banks cutting rates since jobs data in the US signalled the risk of a recession in the world’s largest economy. The US Federal Reserve is expected to start its easing cycle next month, and policymakers in Canada, England and at the European Central Bank have already begun theirs.

By contrast, the Reserve Bank of Australia held borrowing costs steady last week, and governor Michele Bullock has indicated it won’t hesitate to raise rates if needed to bring inflation to heel.

The RBNZ’s updated forecasts show a big drop in the forward track for the cash rate compared to its May projections. They show the average OCR at 3.85% by the end of 2025, compared with 5.14% previously.

Asked to explain the big change in the RBNZ’s policy stance in the space of three months, Orr put it down to slew of recent indicators showing a slowdown in both the economy and inflation. That led to “a material shift in the confidence the committee has that monetary policy is working”, he said.

Inflation cooled to 3.3% in the second quarter, putting the RBNZ’s 1% to 3% target within reach, though a gauge of domestically generated inflation sat at 5.4%.

The central bank on Wednesday forecast inflation to drop to 2.3% in the current quarter, though it doesn’t see a return to the 2% midpoint until mid-2026.

“Recent indicators give confidence that inflation will return sustainably to the target within a reasonable time frame,” the RBNZ said. “However, members noted that monetary policy will need to remain restrictive for some time to ensure that domestic inflationary pressures continue to dissipate.”

Uploaded by Tham Yek Lee