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RUEHPB RUEHRN RUEHROV
DE RUEHWL #0296/01 2560511
ZNR UUUUU ZZH
R 120511Z SEP 08
FM AMEMBASSY WELLINGTON
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RUEHBY/AMEMBASSY CANBERRA 5256
RUEHDN/AMCONSUL SYDNEY 0716
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RUEHZU/ASIAN PACIFIC ECONOMIC COOPERATION
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RUCPDOC/USDOC WASHDC 0248
RUEATRS/DEPT OF TREASURY WASHDC
RUEHRC/DEPT OF AGRICULTURE WASHDC
RUCNMEM/EU MEMBER STATES COLLECTIVE

UNCLAS SECTION 01 OF 02 WELLINGTON 000296 
 
SENSITIVE 
SIPDIS 
 
STATE FOR EAP/ANP, EEB, INR, STATE PASS TO USTR, PACOM FOR 
J01E/J2/J233/J5/SJFHQ 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ETRD PGOV PREL NZ
SUBJECT: RESERVE BANK ANNOUNCES SECOND REDUCTION IN OFFICIAL 
INTEREST RATE TO OVERCOME FEARS OF RECESSION 
 
Ref: WELLINGTON 230 
 
WELLINGTON 00000296  001.2 OF 002 
 
 
¶1.  (U) Summary.  New Zealand's Reserve Bank Governor Alan Bollard 
aggressively slashed the prime interest rate from 8 percent to 7.5 
percent, leaving some economists surprised expecting only a 25-basis 
point move.  The unexpectedly large cut caused the New Zealand 
dollar to slide about US1.5c to just above US65c, providing more 
relief to exporters, with business groups welcoming the lower 
interest rates.  The Reserve Bank's biggest rate cut since 2001 was 
aimed at getting the banks to cut lending rates anticipating a 
25-basis-point cut may have been offset by banks to cover higher 
international costs because of the ongoing world credit crisis.  End 
Summary 
 
Interest Rates Cut Again 
------------------------ 
 
¶2. (U)  On September 11, the Reserve Bank of New Zealand (RBNZ) 
announced that it was reducing the prime interest rate ("Official 
Cash Rate" -- OCR) by 50 basis points from 8.0 percent to 7.5 
percent.  In the RBNZ's monetary policy statement (MPS), the Bank 
indicated that New Zealand's GDP was likely to have contracted in 
each of the first three quarters of 2008, and likely fell by a total 
of 0.8 percent over the preceding nine-month period.  The reduction 
in the OCR marks the second time this year that New Zealand's 
Reserve Bank Governor Alan Bollard has delivered a substantial cut 
(see reftel).  Despite the RBNZ's move, commercial banks have been 
slow in passing on the benefit of cheaper loans to homeowners hoping 
to restore profit margins. 
 
¶3. (U)  Reserve Bank Governor Alan Bollard explained his rationale 
for the making the dramatic cut, saying "the New Zealand economy is 
experiencing a marked slowdown, led primarily by the household 
sector (housing market) and the outlook for the global economy has 
deteriorated further in the wake of continued financial market 
turmoil."  In addition he went on to say, "the New Zealand business 
sector is coming under pressure from both rising costs and falling 
demand while domestic activity is likely to pick up later this year 
as a result of personal tax cuts, increased government spending and 
rising rural (agricultural sector) incomes, we expect a prolonged 
period of household sector adjustment and below-average growth." 
 
¶4. (U)  Recent economic indicators in NZ have trended negative, 
including rising unemployment (although comparatively low at 3.6 
percent), sharply falling construction activity, plunging retail 
sales and sagging house prices (down 4.4 per cent in the past year 
according to Quotable Value figures - NZ's largest property 
information company).  Local economists believe the economy has 
slowed sharply because the New Zealand public has been battling high 
mortgage rates, rising food bills and soaring fuel prices. 
Inflation hit an annual rate of 4 per cent, which is outside the 
RBNZ's targeted 1 percent to 3 percent range.  (Note:  The official 
second quarter GDP data compiled by Statistics NZ which was expected 
in early July will be released at the end of September in order to 
dampen talk of recession.  End note). 
 
¶5. (U)  The RBNZ is projecting annual average Gross Domestic Product 
(GDP) growth to contract by 0.3 percent through early 2009 -- the 
weakest since the recession of the late 1990s -- then rise 2.9 
percent by 2011.  This contraction is deeper than had been expected 
in the June MPS, with the pick-up in growth expected to be more 
robust than previous MPS predictions.  Per September's MPS, with the 
extended period of weak economic growth through the remainder of the 
year, firms expect a sizeable build-up of excess capacity to result, 
making it hard for companies, particularly retailers, to pass on 
increased costs to their customers. 
 
Commercial Banks have been Slow to Pass on Rate Cuts 
--------------------------------------------- ------- 
 
¶6. (SBU)  Despite the earlier move on the part of the RBNZ, 
commercial banks have proved extremely slow in passing on the 
benefit of cheaper domestic money to homeowners.  Mortgage rates 
have barely moved and the difference between what it costs the banks 
to borrow and the interest rate they charge consumers has widened as 
much as 200 basis points in many instances.  Only 18 months ago, the 
difference was 70 basis points.  The commercial banks attribute the 
spread to the fact that they need to borrow significant amounts 
 
WELLINGTON 00000296  002.2 OF 002 
 
 
offshore and New Zealand is charged a risk premium, which has 
ballooned in recent months.  According to local analysts, domestic 
borrowing should be cheaper; "swap rates" (the cost to the banks for 
fixed rate lending) has fallen and will fall further with the move 
by the RBNZ meaning mortgage rates should follow.  The conclusion 
these analysts draw is that the banks are restoring profit margins 
hit by the credit crisis by continuing to charge unreasonably high 
interest rates to home owners.  Given the Reserve Bank's recent OCR 
cut, the pressure will mount on commercial banks to begin reducing 
mortgage rates. 
 
¶7. (U)  The Reserve Bank is forecasting house prices to fall to 10 
percent this year and overall 15 percent from their peak last year. 
"The market is only halfway through that bust," said Bollard.  The 
Reserve Bank's bigger rate cut was aimed at getting the banks to cut 
lending rates because a 25-basis-point cut may have been offset by 
higher international costs because of the world credit crisis. 
However, the commercial banks cuts on September 11 to floating 
mortgage rates would not immediately help overall household budgets 
much because only about 12 percent of loans were on floating rates. 
Only a third of fixed loans come up for renewal in the next year, 
with an average mortgage interest rate of 8.2 percent, so in the 
near term consumers will face higher costs, not lower rates.  The 
real relief for household budgets should come from lower petrol 
prices and tax cuts due next month.  Lower lending rates would not 
rescue the housing market from its present bust. 
 
Comment 
------- 
 
¶8. (SBU)  According to local economic analysts, the RBNZ is now 
following a much riskier monetary strategy than in June, when the 
Bank had been expected to cut rates and then pause to gauge effects 
on inflation and wage rises.  Because fears of recession have 
worsened (and the Labour Government is heading into an election) 
economists believe Bollard is "swinging a big bat to get traction on 
(lower) mortgage rates.  Some anticipate that another 50-point cut 
next month would not be surprising. 
 
MCCORMICK