The cut of 25 basis points came earlier than predicted by most economists and is the first lowering of interest rates in over four years.
Reserve Bank Governor Graeme Wheeler said falling dairy prices and recent rises in petrol prices were the reason as they will slow income and demand growth.
This will increase the risk that the return of inflation to the mid-point would be delayed.
In light of this situation and the expected weakening in demand, Wheeler said a lower New Zealand dollar is needed to put New Zealand’s net external position on a more sustainable path.
“A reduction in the OCR is appropriate given low inflationary pressures and the expected weakening in demand, and to ensure that medium term inflation converges towards the middle of the target range.”
In the post-statement conference, Wheeler said the RBNZ expects that further easing of the OCR may be appropriate, depending on the data, and has factored another cut into its equations.
The Auckland housing market is still of concern to the RBNZ as housing prices continue to increase rapidly, he continued.
However, the RBNZ’s LVR measures and the government’s tax measures should help to moderate the rate of house price inflation, Wheeler said.
“They are not going to fix the problem though. What is required is more supply. It is increased supply that is needed to fix the problem.”
Ultimately, only time will tell what Auckland housing prices will do, but the RBNZ are waiting with interest to see the REINZ data for May, he said.
Wheeler added they would expect to see a decline in floating and fixed mortgage rates in response to the OCR cut, but said that some of it was already priced into the market.
The market responded to the RBNZ announcement immediately.
The New Zealand dollar dropped against both the US and the Australian dollar, while ASB, ANZ and KiwiBank all announced a drop in their floating mortgage rates.
Westpac chief economist Dominick Stephens said that the RBNZ had heavily emphasised that the main rationale for the OCR cut was falling dairy prices and low actual inflation.
However, he was surprised by the early cut – which was the first RBNZ move that was not clearly signalled ahead of time since the 2011 post-earthquake cut, and before that, since 2005.
Stephens felt the RBNZ’s cut condition of weakened domestic demand had not been met and that the inflation condition was finely balanced.
“We expected the RBNZ to remain on hold at this stage, although we did think there was a good chance of a cut later in the year. Instead, the RBNZ has opted to move immediately in anticipation of cooler domestic demand.”
Markets were similarly surprised, with the exchange rate falling almost two cents and two-year swap rates falling 17 basis points, he said.
Stephens said one consequence could be a further drop in fixed mortgage rates, which will stimulate the housing market.
In terms of future cuts, he said that a September follow-up cut is more likely than a cut in July.
