New Zealand Cuts Key Rate By 100 Basis Points to 6.5%

By Tracy Withers

Oct. 23 (Bloomberg) -- New Zealand's central bank cut its benchmark interest rate by a record 1 percentage point to 6.5 percent and foreshadowed further reductions to limit damage from the worldwide financial crisis and a slump in the global economy.

``Economic activity will be further constrained by these international developments,'' Reserve Bank Governor Alan Bollard said in a statement in Wellington today. ``Should the outlook for inflation evolve as projected, we would expect to lower the rate further.''

Central banks have cut interest rates worldwide in an attempt to unfreeze credit markets amid a financial meltdown. Bollard began lowering borrowing costs in July as the economy went into recession, sending New Zealand's dollar tumbling 24 percent and stock prices down 30 percent this year.

``The domestic economy is likely to remain in recession through to the middle of next year at least,'' said Darren Gibbs, chief New Zealand economist at Deutsche Bank AG in Auckland. ``The official cash rate will move to around 5 percent, if not below, by the middle of next year.''

Today's cut is the largest since the Reserve Bank began using the official cash rate in 1999. Nine of 11 economists surveyed by Bloomberg News forecast the move. Two expected a three-quarter point reduction.

Bollard said the market shouldn't expect future rate cuts to be of a similar size.

Currency Bounce

The central bank, which is required to keep average price gains between 1 percent and 3 percent, forecasts the inflation rate will be back in its target range within a year.

New Zealand's dollar pared its declines after the statement because of market expectations Bollard may cut by more. It bought 58.86 U.S. cents at 1:50 p.m. in Wellington from 58.33 cents immediately before the statement.

``With market chatter prior to the meeting of a more than 100-point cut, the decision has seen the New Zealand dollar bounce,'' said Stephen Halmarick, co-head of economic and market analysis at Citigroup Inc. in Sydney.

The Reserve Bank of Australia cut its benchmark rate by 1 percentage point to 6 percent on Oct. 7. India this week cut its rate for the first time since 2004. Canada reduced its benchmark to the lowest since 2004 and foreshadowed more reductions to come.

Bollard cut the rate by a quarter point in July and a half point to 7.5 percent on Sept. 11 as New Zealand entered its first recession in 10 years, contracting 0.2 percent in the second quarter after shrinking in the three months to March.

Export Outlook

He forecast another contraction in the third quarter. Companies also expect sales will shrink in the final three months of the year, according to a survey by the New Zealand Institute of Economic Research Inc.

``Economic activity will be further constrained relative to outlook presented in September,'' Bollard said today. Last month, he forecast the economy would grow 0.6 percent this year and 1.5 percent in 2009.

``New Zealand can expect to face lower demand for exports and credit is likely to be less readily available,'' he said. ``Consumers and businesses are likely to be more cautious and curtail spending.''

While the economy contracts, high fuel and food prices have driven faster inflation. Consumer prices rose at the quickest pace in 18 years in the 12 months ended Sept. 30, Statistics New Zealand said this week.

``With weaker short-term growth and sharply lower oil prices we now expect that annual inflation will return to the target band around the middle of 2009,'' Bollard said. He didn't provide detailed forecasts.

Consumer Confidence

Still, the central bank has concerns that domestic inflation remains ``stubbornly high,'' led by property taxes, electricity prices and construction costs, Bollard said.

The economy has contracted amid a slump in consumer confidence and a plunge in the housing market. Exports, which make up 30 percent of the economy, are slowing as a drought curbs farm production and world butter and cheese prices decline.

House prices dropped 6.1 percent in September from a year earlier. Home sales are close to a 16-year low.

The slowdown in consumer spending will be offset by the New Zealand dollar's decline, lower fuel prices and tax cuts, Bollard said today.

The collapse of Lehman Brother Holdings Inc. last month sparked a crisis of confidence in financial markets, sending stock markets into a freefall and prompting governments around the world to cut borrowing costs and boost capital for banks.

Global Rates

The Federal Reserve, the European Central Bank and counterparts in London, Sweden and Canada cut their benchmark interest rates by half a point in a coordinated move on Oct. 8 to restore confidence and limit damage to their economies.

``The timing and extent of reductions over the coming months will depend on evidence of actual reductions in domestic cost pressures as well as how the global financial developments play out,'' Bollard said today.

Bollard will cut the rate to 6 percent at his next review on Dec. 4, according to the economists surveyed by Bloomberg. The rate will be 5.5 percent by March, the lowest level since April 2004, they forecast.

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