Opinion: Why the RBNZ should not cut the OCR below 5%

By Roger J Kerr Interest rates continue to fall, with the debate now moving on to whether the moneymarkets will overshoot on the downside with their expectations that the RBNZ have another 2.00% to cut from the current 6.50% OCR. Just as the markets could only see future increases 12 months ago when interest rates were 8.50%, the markets are now totally convinced that the NZ economy will be in a recession for a very long time and interest rates need to go substantially lower yet. The probability is increasing that both the markets and the RBNZ will take interest rates too low on this cycle. Much depends on how the economy is looking in three and six month's time. So much of that outlook is dependent on whether the world economy deteriorates further and our export commodity prices go lower still. What we do know from history is that when NZ short-term interest rates get below 5.00% they do not stay there for long. The low interest rates generally cause a weak NZD exchange rate and the export sector pulls the overall economy back up to positive GDP growth. I remain reasonably confident that the same will occur on this cycle, it is only a question of timing. To put the whole interest rate cycle scenario into some context, my view is that both borrowers and investors will in years to come look back on the late 2008/early 2009 period as the bottom in the interest rate declines and that the markets probably did become somewhat too pessimistic about the future economic performance. You can understand why the markets are behaving as they currently are, but prudent risk management requires the ability to look-through the short-term and settle on probabilities of what the medium to long-term will look like.    --------------- *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