Interest rates 'headed for 5.5pc'

ANDREW GORRIE/Dominion Post

The Reserve Bank could cut interest rates as soon as next week - despite inflation heading for 5 per cent - but economists say it is a close call and September may be more likely.

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The Reserve Bank will slash interest rates sharply - by as much as 75 basis points - but not till October 23, standing back from global central bank rate cuts.

There had been a growing expectation that Reserve Bank governor Alan Bollard would cut the official interest rate by as much as 100 basis points this week, after a similar move by Australia on Tuesday and coordinated global rate cuts of 50 basis points yesterday.

In a statement, Dr Bollard pointed to his next planned announcement on October 23 - interpreted by economists as ruling out a rate cut before then. Dr Bollard surprised markets by cutting the official rate by 50 basis points to 7.5 per cent last month.

Meanwhile the Kiwi dollar has been on a wild ride, plunging to a five-year low of US57.75c before recovering to US61c late yesterday. The currency was dragged down by a falling Australian dollar.

Dr Bollard said the Reserve Bank was monitoring international developments closely.

"At the moment the New Zealand financial system is working satisfactorily. It has held up relatively well in the face of the volatility and disruptions that we are seeing internationally," he said.

The Reserve Bank also said it would speed up the process of lending money to banks if they needed it.

The central bank offered to lend against packages of mortgages offered by banks, even before those so-called "Residential Mortgage-Backed Securities" got a formal credit rating.

The Reserve Bank would only lend 81 per cent of the face value of the packaged mortgages, so it was not "easy money", a bank economist said. Rather, it was seen as another option to raise money when credit markets were tough.

That was another incremental step to make more money available to banks if they needed it, though the Reserve Bank had already agreed to lend against "triple A" rated mortgage backed securities a few months ago.

The banks are still packaging these securities and the move yesterday was aimed at speeding up the process if banks needed cash.

Westpac markets economist Michael Gordon said for the Reserve Bank here, moving rates now or in a fortnight would make no difference. By comparison, the global rate cuts were a vital confidence measure.

Meanwhile, ASB Bank economists said they expected a 75 point cut in a fortnight, with a "strong chance" the cut might be 100 points.

That would be followed by another 50 points in December.

ASB chief economist Nick Tuffley said he read Dr Bollard's statement as an intention to wait till October 23 before cutting rates.

"We have been escaping a lot of the turmoil hitting other financial systems. We are in good shape here, comparatively speaking," he said.

Dr Bollard could drop rates a long way without damaging the inflation target, Mr Tuffley said, given the headwinds facing offshore economies.

Bank of New Zealand economists said Dr Bollard was resisting a knee-jerk reaction to the global financial market chaos and some overseas share markets in freefall.

Bank of New Zealand expected Dr Bollard to cut rates 100 basis points by the end of the year. BNZ tipped a 50 points cut on October 23 and the same again in December. A 75 point cut rated a 40 per cent chance and 100 points was just a 10 per cent chance.

Rates would eventually drop to 5.5 per cent but could go even lower.

- © Fairfax NZ News