New Zealand dollar tumbles to near 5-year low after RBNZ cuts interest rates

The New Zealand dollar tumbled early on Thursday after the Reserve Bank of New Zealand (RBNZ) announced it cut interest rates. The kiwi fell versus the dollar to $0.7015 immediately after the news, after gapping down from a level of $0.7210. The currency continued to fall throughout the Asian session to reach a low of $0.7009, the lowest level since September 2010.

The benchmark interest rate – known as the Official Cash Rate (OCR) – was reduced by 25 basis points to 3.25 percent.

A statement by the central bank’s Governor Wheeler said that the New Zealand economy is growing at an annual rate of around three percent. Low interest rates have been supporting growth, and particularly low fuel prices. Also construction activity has helped. However, the decline in export commodity prices that began in mid-2014 is proving to be more challenging as weaker dairy prices and the recent rises in petrol prices will slow income and demand growth and increase the risk that the return of inflation to the mid-point would be delayed.

Inflation has been low due to falling import prices and the strong growth in the economy’s supply potential. Wage inflation and inflation expectations have been subdued.

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.

With the fall in commodity prices and the expected weakening in demand, the exchange rate has declined from its recent peak in April, but remains overvalued. A further significant downward adjustment is justified. In light of the forecast deterioration in the current account balance, such an exchange rate adjustment is needed to put New Zealand’s net external position on a more sustainable path.

House prices in Auckland continue to increase rapidly, and increased supply is needed to address this. The proposed LVR measures and the Government’s tax initiatives planned for 1 October 2015 should ease the impact of investor activity.

Growth in the global economy remained moderate. Data on economic activity in the US, China and Australia has been mixed, although there has been some improvement in the euro area and Japan. Volatility in financial markets has increased.

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