Economy

Would an interest rate cut help vaccinate the economy?

Most economists expect the Reserve Bank to hold the Official Cash Rate on Wednesday, but Bernard Hickey argues there's a case for a 50 basis point cut to vaccinate the economy against a much more serious hit from the Wuhan coronavirus.

The Reserve Bank's Monetary Policy Committee is meeting early this week for the first time this year to decide on whether to cut the Official Cash Rate from its current 1.0 percent to stimulate the economy, or to offset an economic shock.

The effects of the Wuhan coronavirus on the global and local economy over the next 12 to 18 months will be the biggest and most difficult topic of conversation, largely because it has hit hard and fast and appears much bigger in the wing mirrors than it may actually be in real life. But there's little fresh data to base a judgment on, and the risk is that a swerve away from the fast over-taking coronavirus could do more damage than being rear ended. The committee just doesn't know.

Economists believe the central bank's initial instincts should be 'do no harm' and just hold the OCR.

Inflation is well under control and, if anything, the data (pre-coronavirus) was mildly positive. The housing market here is heating up nicely again, even in Auckland. Business and consumer confidence are at least not sliding any more, albeit without any aggressive rebound. The global economy stabilised in November and December as China and America put their tit-for-tat trade wars onto the backburner and the US Federal Reserve's soothing noises kept global stock markets firing ever higher.

But when the facts change...

But even over the last couple of days it has become clear the disruption caused to global supply chains by China's cordoning off of cities with 60 million people and bans on Chinese tourists and students could hurt both the global and local economies significantly, particularly if it drags on into March and beyond.

ANZ Chief Economist Sharon Zollner said the effects of the virus could reduce New Zealand GDP by around 0.5 percentage points in the March and June quarter. She still expected the Reserve Bank to hold, but to leave open the option of responding at a later date.

"A temporary shock lends itself to a sharp recovery, but there’s a risk the slowdown is more prolonged," Zollner said.

"If that risk materialises, the RBNZ and Government are likely to respond, but for now, the RBNZ can afford to be patient and see how things evolve," she said.

50 basis point cut?

Former Reserve Bank economist Michael Reddell, who helped prepare forecasts for such decisions, recommended a 50 basis point cut.

"Twice before the Reserve Bank has cut the OCR in response to truly-exogenous external events," Reddell wrote in a blog post, pointing to 50 basis point cuts after the 9/11 attacks and the Christchurch earthquakes.

The 2003 SARS outbreak was also a factor in a rate cut then.

"Set against the backdrop of those three cuts, I reckon the case for an OCR cut now –  even it had to be pulled back in six months’ time –  is stronger than in any of those other cases," Reddell wrote.

Given inflation is moribund and business expectations for inflation ten years ahead are now both below 2.0 percent for the first time, there would be little to lose.

My view? An insurance cut would make sense

The Reserve Bank should cut the OCR again by 50 basis points to 0.5 percent to stimulate inflation and drag unemployment significantly below 4.0 percent in a way that fires up wage inflation and expectations.

The Reserve Bank's survey of business' and economists' expectations of inflation, interest rates, wages and GDP was released on Friday.

The March quarter survey found businesses' expectations of wage inflation fell again, which again supports the need to turn them around with more aggressive monetary and fiscal policy action.

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