March 10, 2016 / 1:10 AM / 2 years ago

NZ's surprise rate cut sends kiwi tumbling, stokes talk of global currency war

A New Zealand ten dollar note sits underneath a United States one dollar bill in the window of a currency exchange teller in Sydney, Australia, March 10, 2016. REUTERS/David Gray

WELLINGTON (Reuters) - New Zealand’s central bank unexpectedly cut interest rates to a record-low 2.25 percent on Thursday, triggering a slide in the local dollar and sparking talk of a global currency war as countries seek to revitalize their economies in a world of slow growth.

New Zealand’s move to trim the Official Cash Rate by 25 basis points follows the Bank of Japan’s historic decision in January to adopt negative interest rates and comes ahead of the European Central Bank’s policy review later in the day when it is expected to cut rates deeper into minus territory.

The Reserve Bank of New Zealand cited low domestic inflation and a deteriorating global economic outlook as factors in Thursday’s rate cut, on the same day as Moody’s ratings agency warned of a credit risk to the country’s banks from tumbling dairy prices.

RBNZ Governor Graeme Wheeler said policy makers were concerned about slowing growth in China, and highlighted risks around Beijing’s unexpected devaluation of the yuan in August - a move that sparked fears of a global currency war.

“If China had a very significant and prolonged devaluation it would in essence spread deflation around the world,” Wheeler told reporters at a press conference.

Given China’s dominant role in the international trading system “by and large every other currency would be appreciating against the Chinese currency,” he said.

The specter of currency devaluations took center stage at a meeting of G20 policy makers in Shanghai this month, especially after China’s August move stoked uncertainty over its currency policy and after Japan’s surprise shift to negative rates.

The G20 finance ministers however played down talk of beggar-thy-neighbor policies and agreed to inform each other in advance about policy decisions that could lead to currency devaluation.

While Thursday’s RBNZ rate cut wasn’t aimed at bringing down New Zealand’s exchange rate, Wheeler said that “pretty well most central banks would like to see their exchange rates lower.” A decline in the New Zealand dollar would “be appropriate given the weakness in export prices,” he said.

KIWI TUMBLES

The New Zealand dollar NZD=D4 tumbled more than a cent and 2-year swap rates dropped to around 2.25 percent from around 2.45 percent late Wednesday as the RBNZ indicated that at least one more rate cut was likely.

“If there was a strong rationale for today’s cut it was that the RBNZ wanted to shock the currency market by delivering a rate reduction that was unexpected,” said BNZ Head of Research Stephen Toplis.

The slowdown in China and generally cooling global demand have hurt growth in New Zealand and pulled inflation sharply under the RBNZ’s 1-3 percent target band. The central bank is now forecasting annual inflation at 1.1 percent by end-2016, down from its prior projection of 1.6 percent made at the December policy review.

Still, at 2.25 percent New Zealand has among the highest policy rates in the developed world - well clear of the U.S. Federal Reserve and the likes of Japan and the ECB - and ample room to deliver further cuts.

A snap Reuters poll showed 11 of 12 economists see NZ’s policy rate at 2.00 percent by June, versus only 2 of 14 respondents who saw a similar outcome in an earlier survey taken prior to Thursday.

On the domestic front, RBNZ’s Wheeler warned that the dairy sector faces challenges as the price of global dairy - the nation’s biggest export earner - remain subdued.

That risk was underscored on Thursday by Moody’s Investors Service. It said the decision by dairy giant Fonterra Cooperative Ltd. (FCG.NZ) (FSF.NZ) this week to lower its forecast payout to its farmer shareholders is “credit negative for New Zealand banks.”

Reporting by Rebecca Howard and Jane Wardell, Editing by G Crosse & Shri Navaratnam

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