Bollard Cuts New Zealand's Rate By Half Point to 7.5%

By Tracy Withers

Sept. 11 (Bloomberg) -- New Zealand's central bank cut its benchmark interest rate by a half point to 7.5 percent, more than expected by most economists, saying the economy is in a recession and inflation will slow.

The nation's currency dropped to a 22-month low, bond yields fell and stocks gained after Reserve Bank Governor Alan Bollard said in Wellington today it was ``appropriate to move toward a less restrictive stance'' as inflation eases.

New Zealand's economy contracted in the first quarter and Bollard, 57, today joined the Treasury Department and economists in forecasting it also shrank in the three months to June 30, putting the nation in its first recession since 1998. Bollard said inflation will return below the 3 percent limit of his target range by the first quarter of 2010.

``There are real reasons for the Reserve Bank of New Zealand to be quite worried about the economy,'' said Su-Lin Ong, senior economist at RBC Capital Markets Ltd. in Sydney. ``It's clear conditions are far too tight.''

Ong was the only one of 15 economists surveyed by Bloomberg News to predict the half-point cut. The rest forecast a quarter- point reduction.

New Zealand's dollar fell to as low as 65.16 U.S. cents from 66.26 cents immediately before the statement. That's the lowest since Oct. 2, 2006. It traded at 65.25 cents at 12:46 p.m. in Wellington. The three-year bond yield fell 19 basis points to 5.72 percent and the NZX 50 stock index rose 1 percent.

Economic Risk

Today's reduction is the largest since 2001 when the Reserve Bank cut by a half point twice in the months following the U.S. terrorist attacks.

Traders expect Bollard will cut rates a quarter point at his next meeting on Oct. 23, according to a Credit Suisse index based on swaps trading. Bollard said the timing and size of future reductions depends on the outlook for inflation and the currency.

```We've got room to move,'' he said in an interview today. ``We're in a loosening mode at the moment.''

The central bank said the economy probably shrank 0.2 percent in the second quarter, after forecasting 0.2 percent growth in its June policy statement. The economy will also contract 0.3 percent in the third quarter, it said.

Growth in the year ending March 31, 2009, will be 0.3 percent, the weakest in 10 years, the bank forecast. The economy expanded 3.1 percent in 2007.

Fuel Prices

Drought, the increasing cost of credit, higher fuel prices and a housing slump combined to stall the economy, Bollard said. The outlook for the global economy has deteriorated in the wake of financial-market turmoil, he said.

Exports fell for a second straight quarter in the three months to June 30 as dry weather curbed dairy production and shipments of milk powder and cheese slumped, according to a government report yesterday.

Dairy products are the nation's largest export. Total overseas sales make up 30 percent of the economy.

Retail sales fell by the most in at least 13 years in the second quarter as consumer confidence slumped and record-high gasoline prices left households with little to spend on discretionary goods.

``Consumers are watching what they spend very carefully,'' said Rod Duke, managing director of retailer Briscoe Group Ltd. ``The downturn in consumer confidence affected by steep increases in basic cost of living, petrol and bank interest rates, has hit retailers hard.''

House Sales

Auckland-based Briscoe said on Sept. 5 that first-half profits at its sporting goods and home-ware stores slumped 71 percent amid declining sales.

House sales fell to a 16-year low in June and residential construction dropped for three consecutive quarters. The jobless rate rose to a two-year high in the second quarter.

Central bankers around the world are grappling with slowing economic growth while surging fuel and food prices fan inflation.

The Reserve Bank of Australia this month lowered its benchmark interest rate for the first time in seven years as economic growth weakens. Governor Glenn Stevens said this week it may be six months before inflation eases.

The European Central Bank last week kept interest rates unchanged at a seven-year high, citing inflation concerns. Yesterday, it lowered its forecast for euro-region growth and said Germany faces a recession. The Bank of England kept its rate steady after economic growth stalled in the three months ended June 30.

Inflation Forecast

New Zealand's inflation rate will probably accelerate to 4.9 percent in the year ending Sept. 30, the fastest pace since 1990, the Reserve Bank said today.

Annual inflation will be 4.5 percent by March 2009 before slowing to 2.8 percent a year later, Bollard said in a statement today. In June, the central bank expected inflation would stay above 3 percent until mid-2010.

``We remain mindful of the risks to inflation,'' said Bollard. The extent of the decline will depend on the responses of wage inflation and inflation expectations, he said. A weaker exchange rate will underpin the price of imports.

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