N.Z. Cuts Key Rate a Quarter Point as Economy Slows

By Tracy Withers

July 24 (Bloomberg) -- New Zealand's central bank cut its benchmark interest rate by a quarter point to 8 percent, the first reduction in five years, saying slowing economic growth will curb inflation. The nation's currency fell.

``Economic activity is likely to remain weak over the remainder of 2008,'' Reserve Bank Governor Alan Bollard said in a statement in Wellington today. ``Provided that the outlook for inflation continues to improve and there is no excessive exchange rate depreciation, we would expect to lower rates further.''

New Zealand's economy contracted in the first quarter, putting the nation on the brink of its first recession since 1998, as drought, a slumping housing market and rising credit costs stall spending. Bollard says inflation will return below the 3 percent limit of his target range within two years.

``This is a rate cut to compensate for the tightening of financial and credit markets,'' said Matthew Johnson, a senior economist at ICAP Australia Ltd. in Sydney. ``The economy is broken. The construction industry has turned turtle, the housing market is going backwards and their equity markets have fallen. It's all pretty ugly.

``Admittedly inflation is high, but rates at 8 percent are still very tight,'' Johnson said, adding that he forecasts another 50 basis points of cuts by the end of this year.

New Zealand's dollar fell to a six-month low of 74.30 U.S. cents from 75.02 cents immediately before the statement. The currency, which dropped 2.7 percent in the seven days before the decision, bought 74.44 cents at 9:55 a.m. in Wellington.

Unexpected Decision

The yield on a three-year benchmark bond fell 12 basis points to 6.11 percent. A basis point is 0.01 percentage points.

Just four of 15 economists surveyed by Bloomberg News last week predicted today's decision. Eleven expected no change until the next review on Sept. 11.

Bollard had kept the official cash rate at 8.25 percent, the highest of any nation with an Aaa credit rating, since July last year. Today's is the first rate cut since July 2003.

While official rates have been unchanged the past year, local banks have been raising borrowing costs as they have had to pay more for credit overseas.

Today's rate cut ``will help to mitigate the effect of these increases on the actual borrowing costs paid by firms and households,'' Bollard said.

Global Dilemma

Central bankers around the world are grappling with slowing economic growth while surging fuel and food prices fan inflation. Consumer prices in the U.S. surged 5 percent in the year through June, the biggest jump since 1991, and in Europe they climbed 4 percent, the fastest pace in more than 16 years.

Bollard was under pressure to cut interest rates to help New Zealand avoid a prolonged recession.

``More unpleasant international news has emerged since the June statement and there is a risk that the domestic economy will slow further,'' Bollard said today. ``The ongoing correction in the housing market together with very high oil prices will limit household spending and constrain the extent of recovery.''

Gross domestic product contracted 0.3 percent in the first quarter. Eight of 13 economists surveyed by Bloomberg expect it also shrank in the three months ended June 30.

Sales of houses slumped for a fourth straight month in June and prices fell, the Real Estate Institute said on July 11. Consumer confidence fell to a record low in the two weeks ended June 29 because of the threat of recession, according to a survey by research firm Roy Morgan.

Retail Sales

Slowing sales are eroding earnings at retailers such as Hallenstein Glasson Holdings Ltd., which said on July 10 that full-year profit will fall at least 28 percent. The clothing retailer became the third New Zealand store owner to cut earnings forecasts in two weeks.

``The current environment is the most challenging experienced for a number of years,'' Chief Executive Officer Shayne Quanchi said. ``There is fierce competition for consumers' wallets.''

New Zealand's biggest trade union said last week companies will face demands for higher wages as food and fuel prices soar.

``The weaker economy is expected to reduce pressure on resources, making it more difficult for firms to pass on costs and for higher wage claims to be agreed.''

The jobless rate was 3.6 percent in the first quarter, the sixth-lowest of 27 economies in the Organization for Economic Cooperation and Development that use standardized rates.

Consumer prices rose 4 percent in the year ended June 30, the fastest annual pace in two years.

Inflation will peak at 5 percent in the year ending Sept. 30, the highest rate since the fourth quarter of 1990, Bollard said today. Inflation will return to the central bank's 1 percent-to-3 percent target range in the medium term, he said.

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