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Why the OCR won't go much lower

Published: 7:20AM Friday March 13, 2009 Source: ONE News

The Reserve Bank on Thursday signalled that the recent cycle of big interest rate cuts is coming to an end after the bank cut the official cash rate from 3.5 to 3%.

The more modest 50 basis point cut followed two hefty 150 basis point adjustments in December and January.

Bollard says the central bank has had to loosen monetary conditions given the bad economic news internationally, especially over the last couple of quarters.

However, he expects that in the coming months there will be two cuts of a smaller size.

Bollard says the OCR will likely trough at 2.5% mid year and it is highly unlikely that it will go any lower than 2%.

"Were we to track down like the Bank of England, like the Federal Reserve, like the Bank of Japan to rates that are very near zero, we would find in our particular case that monetary policy would become much less effective," he says.

Any lower than that and Bollard says there would be a reduced return for domestic savers; the potential for negative real rates; and less interest from foreign investors who fund New Zealand's deficit.

So far, Bollard says the exchange rate has performed well through the series of OCR cuts.

"It's reflected in our falling commodity prices, it's reflected our external current account and it's helping in our forecasts to turn that around. So after about a year we see a significant improvement in the current account and that's driven very much off this exchange rate," he says.

Following the trough forecast for the middle of the year, Bollard sees a "fragile recovery" for New Zealand's economy.

However, he is quick to reiterate his comments made during his OCR announcement on Thursday that the world is in historically uncertain times.

He says the Reserve Bank has already had to revise its December outlook in January and February, and with each revision the outlook gets worse.

'If some of that were to continue then it would be a slower more fragile recovery for New Zealand."