Bollard Says Weak N.Z. Economy Justifies Easing Bias

By Tracy Withers

July 30 (Bloomberg) -- New Zealand's slowing economy will ease inflation over the next two years, justifying further cuts in the benchmark interest rate, Reserve Bank Governor Alan Bollard said today.

``Our judgment is that the weakness in the economy will be sufficient to bring inflation and inflation expectations down over the medium term,'' he said in a speech in Auckland. ``We have thus adopted an easing bias in our monetary policy.''

Bollard cut the official cash rate a quarter point to 8 percent last week, the first reduction in five years, and said he expects to lower borrowing costs further. A drought, a housing market slump and soaring fuel and food costs have curbed domestic demand, fanning expectations the economy slipped into a recession in the first half of the year.

``Easing is clearly the correct stance with the economy in a recession,'' said Shamubeel Eaqub, economist at Goldman Sachs JBWere Ltd. in Auckland. ``The Reserve Bank should move to a neutral rate of about 6 percent as soon as possible.''

New Zealand's dollar fell to 73.55 U.S. cents at 4:55 p.m. from 73.80 cents immediately before the speech, nearing a 10- month low seen late yesterday.

The currency is the worse-performing of 16 major currencies against the U.S. dollar the past three months. Still, Bollard today said the exchange remains high on a trade-weighted basis.

Recession Risk

New Zealand's economy contracted 0.3 percent in the first quarter. Eight of 13 economists expect it also shrank in the three months ended June 30, putting the nation in its first recession since 1998.

``Our judgment at this stage is that the contractionary effects of the housing downturn, high oil prices and the global credit crunch will substantially outweigh the stimulus from high export prices and projected expansionary fiscal policy,'' Bollard said. Notes of his speech were e-mailed to Bloomberg.

Bollard said the economy has been subjected to a price shock from record-high oil prices, and the adjustment to this shock has to occur through a combination of lower wages and profit margins.

``It does not make sense for the Reserve Bank to try to prevent this adjustment,'' he said.

`Room to Fall'

New Zealand interest rates, which are the highest of any nation with an Aaa credit rating ``have room to fall in response to the weakening economy,'' Bollard said.

Still ``the key requirement is that policy is kept tight enough to ensure that inflation expectations remain anchored,'' he said. ``Currently inflation expectations appear to remain anchored at a level consistent with the inflation range, though there is a slight upward drift.''

New Zealand's annual inflation rate accelerated to 4 percent in the year ended June. Bollard, who is required to keep prices between 1 percent and 3 percent, said the measure may rise to 5 percent this year before returning to less than 3 percent by mid-2010.

To contact the reporter on this story: Tracy Withers in Wellington at twithers@bloomberg.net.