OCR cut to 1%: Is recession around the corner?

Thursday, 8 August 2019

With an official cash rate of 1 per cent, Reserve Bank governor Adrian Orr doesn't have a lot more ammunition to deploy.

A bigger-than-expected cut to the official cash rate this week does not signal a recession immediately around the corner, but no one can afford to be complacent about 'frightening' economic conditions, economists say.

The Reserve Bank surprised markets when it cut the official cash rate from 1.5 per cent to 1 per cent. Commentators had predicted it would be cut by half that much, to 1.25 per cent.

Brad Olsen, an economist at Infometrics, who described the move as 'taking a chainsaw to the economic outlook' said it was a big step, which highlighted the extent of weakness in the economy and concerns about the international environment.

Another rate cut is predicted by the end of the year.

* Mortgage rates fall and dollar dives as Reserve Bank sends cash rate down to record 1% low

* Fixed-term borrowers only get fraction of official cash rate cut**

A RECESSION COMING?

Olsen said, while it was unlikely New Zealand would officially enter a recession – when gross domestic product declines year-on-year for two consecutive quarters – 'the signs aren't pointing to anything good'.

He said his organisation had been forecasting for the last year or 18 months that the economy was going to slow. 'The risk is that it is going to slow more than anyone previously expected.'

Growth in gross domestic product was estimated at 2 per cent a year in the June quarter, compared to 3 per cent in June 2018.

Olsen said all the economic forecasts pointed to nothing improving over the next two years. 'Everything is on the same track or going even worse.'

Economist Shamubeel Eaqub agreed the cut didn't mean a domestic recession was imminent.

'It just means the Reserve Bank has a penknife in a sword fight,' he said, 'so they're doing as much as they can as early as possible.'

INTERNATIONAL CONCERNS

The economists pointed to risks in the global economy as a significant worries for New Zealand.

Internationally, growth is slowing and trade tensions are escalating.

Eaqub said there was an international 'race to the bottom' to devalue currencies and, as a result, boost exporters in an increasingly strained trade environment. New Zealand had to be part of that to avoid strangling its exporters with a high dollar.

Central banks around the world were aware that asset prices – such as shares and property – were at high levels and wanted to avoid those bubbles popping, he said.

'What is happening in the global economy is very frightening,' he said. 'Trade wars are escalating in a way that is unchartered waters.'

Eaqub said the current level of international trade tension had not been seen since World War II. The world had since been on the opposite track, with more consolidation and integration.

That meant shocks from things such as the US-China tariff trade war and Brexit could now spread quickly and easily.

WHAT SHOULD WE DO?

There's not much room left for the Reserve Bank to cut rates if a recession were to hit.

The theory is that reducing the cash rate then lowers the cost of borrowing, which makes it easier for people to take out loans to spend and get the economy moving again.

But the lower the cash rate, the less of an impact reductions in it have on what banks charge.

ASB chief economist Nick Tuffley said, with a record low rate, the Reserve Bank had less ammunition to deploy if things deteriorated.

Other countries in that situation have used quantitative easing, where money is pushed into the economy by central bankers.

But Tuffley said it could be up to the Government to step in if the economy seriously needed saving.

Treasury has suggested the Government would need to consider tax cuts and cash payouts to New Zealand households.

Debt levels were low by global standards and it was running surpluses, which gave it room to move, Tuffley said.

Eaqub said he was not a believer in quantitative easing. 'Quantitative easing generally inflates asset prices. Unless it flows to the real economy, like cash handouts to low-income households, it won't be effective.'

The Government could fast-track its infrastructure spend and give tax cuts to poorer households, he said. 'Not for rich people who won't spend it but poor people who will.'

Olsen agreed a tax cut could boost the economy. 'One way is to say 'here's a bit more money in your back pocket, go and spend it'. Grant Robertson could say to Inland Revenue, give back $500 to everyone who has paid more than $1000 in tax this year. '

He said, although the economy was not at a crisis point yet, the Government needed to consider what it could do if it was.

It would take time to get any policies through the parliamentary process. 'Now is the time to plan and it's very quickly slipping away. If we don't have a plan we're in a much riskier place than we would have been.'

Olsen said it was prudent for consumers to be careful and think through big investments.

'But that's just general advice in life, isn't it? In the economy in general, too much cautiousness from consumers is not going to help the economic outlook at all. It becomes a self-fulfilling prophecy.'