Explainer: the RBNZ’s shock move to cut interest rates by 50 basis-points

The Reserve Bank of New Zealand shocked financial markets yesterday by cutting interest rates by 50 basis-points.

What happened at this month’s RBNZ meeting?

The Reserve Bank of New Zealand shocked financial markets yesterday by cutting interest rates by 50 basis-points. Coming into the meeting, a 25-basis point rate cut from the central bank was considered all but certain. But few expected what was effectively a “double-cut”. The chances of such a move was considered barely a 2 per cent chance, with no surveyed economist calling the move. The RBNZ’s actions caught the attention of markets participants, as a result. Afterall, anything greater than a 25-basis-point move in interest rates in the one-go by a developed market central bank has traditionally been considered an emergency measure.

Why did the RBNZ do what it did?

The RBNZ put forth its argument for cutting interest rates by 50-basis-points in the press release accompanying its decision. Acknowledging that economic data is still relatively solid in the New Zealand economy – for one, employment data released just the day prior revealed an unemployment rate at decade lows – the RBNZ argued that global economy is at significant risk of slowing down – the consequences of which would quickly manifest in domestic fundamentals. Such a dynamic would undermine the central bank’s inflation and employment objectives. The necessary remedy for these risks to New Zealand’s economy, it was judged, is an immediate, pre-emptive and aggressive cutting of the overnight cash rate.

Why is it significant?

Arguably, the RBNZ’s decision to aggressively cut interest rates in the face of a forecast economic slowdown marks a significant milestone – not just for the RBNZ, but also other global central banks. It’s gone about and done what other monetary policymakers across globe have hinted-at, but not yet executed: slashing interest rates not necessarily in response to bad economic data, but in anticipation of it. This expands, in practice, the mandate of central banks, from one whereby policy is set according to lagging-measures of employment and price stability, to one whereby policy is set strategically in advance, and with total, future economic management in mind.

How have the financial markets responded?

Such was the surprise of the RBNZ’s decision, financial markets reacted with vigour to the news. The New Zealand Dollar shed as much as two-per cent during Asia trade. The Australian Dollar also tumbled, trading briefly at 10-year lows within the 66-cent level, as interest rate traders increased bets that the RBA may soon adopt a similar dovishness in its policymaking. The RBNZ’s assertiveness managed to inspire a level of bullishness in global stock markets, with investors inferring that the RBNZ’s actions will be replicated by the likes of the ECB and US Fed. Global bond yields pushed to new multi-year lows consequently, driving another rally in gold and the Japanese Yen.

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