Opinion: Why Dr Doom should not cut the OCR to 2%

By Roger J Kerr Local financial and investment markets will be firmly focused this week on the RBNZ's view of life and the economy with the MPS release on Thursday. Alan (Dr. Doom) Bollard should be true to form and can be expected to offer all sorts of cataclysmic consequences for the NZ economy due to the global economy imploding. In recent speeches the Governor has concentrated on the enormous loss of wealth globally due to sharemarkets, property and other investments assets collapsing in value by as much as 40% over this past year. Maybe the short-termism pervading the RBNZ in recent years caused him to inadvertently forget the 200% rise in value of many of these investment assets over the five years prior to a year ago. Having just returned from a visit to the financial capitals of the world, the Governor will struggle to be optimistic about anything. This is the danger of only speaking to bankers, economists and central bankers. If the 0.50% cut in the OCR is now a "given" the real interest will be on the RBNZ's outlook for the NZ economy. Their GDP growth and inflation forecasts for the next 12 months could be anywhere between -1% and +2% and still be considered in line with the private sector forecasts for both measures, that's because the divergence in opinion right now is massive. At one extreme, NZIER forecast +1.1% GDP growth for the NZ economy for the year to 31 March 2010. At the other end of the scale ANZ Bank economists forecast the economy to contract by 3.00% over the same period; that is, minus 3.00%. Interestingly, NZIER see the upturn to positive growth coming from domestic spending as tax cuts, lower mortgage rates and lower petrol prices puts extra dollars in consumer's pockets. The ANZ believe that the very same consumers will be deleveraging to billy-o, and thus reduced retail spending will be what pulls to overall economy down. My view is that both will be wrong. We see flat business investment, flat retail spending and marginal improvement in export activity towards the end of the year producing annual GDP growth of about 0% to +0.5% by this time next year. Some of our clients in the fishing, forestry, agriculture and horticulture industries are more profitable today than two years ago when a higher Kiwi dollar and high fuel/freight costs were really hurting them. However, I doubt that the RBNZ's appreciation of what is really going on in the export economy will reflect this improved situation. Of course, it is harder to sell export product globally as buyers struggle to get trade finance and are scaling back some orders. Countering the tougher international trading conditions are much lower freight costs, improved prices in NZD terms and agriculture production no longer having the threat of drought. It always comes back to export commodity prices and signs are better on this front with dairy prices finally finding some stability. The RBNZ analysis of past and future forecast inflation will also be of considerable interest. What we do know is that the deflation in imported consumer products that has kept core inflation low (excluding food and energy) over recent years will no longer be there as an offset. We don't expect major price increases in this area, but the decreases have long gone. Unfortunately the non-competitive (public sector and monopoly providers) part of the economy is not about to reduce prices, or even hold their prices at current levels. Let's hope the RBNZ inflation analysis examines these non-competitive realities of the NZ economy. What does all this mean for the end-point game in the OCR cuts and monetary loosening? My view is that the RBNZ will come to the same conclusion we have, further OCR reductions below 3.00% are now probably counter-productive for the economy. There are dangers for the currency (already down 35% over the last 12 months) in having NZ interest rates below Australia's. We need voluntary capital inflows to fund the large current account deficit, and we will not attract those funds in if we are below Australia. The RBNZ have failed miserably to meet one of their objectives of controlling inflation without undue volatility in interest rates, exchange rates and output. They should resist the very short-term and changeable calls of the bank economists for a 2.00% OCR and look to the medium-term of more stability in financial market variables. If that can be achieved there has to be more hope that companies in our big export industries will start to invest in their businesses again. When that happens the economy will be back on a sustainable growth path again. ---------------- * Roger J Kerr runs Asia Pacific Risk Management. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com