New Zealand’s Rate Cut Hurts Currency as Investors Look for Higher Yields

New Zealand’s central bank cut its benchmark interest rate to a record low, reducing the attractiveness of the nation’s assets as officials from Beijing to London move to contain inflation by raising borrowing costs.

Governor Alan Bollard today lowered the official cash rate half a percentage point to 2.5 percent and signaled no change until next year, citing the economic damage of an earthquake in Christchurch. Ten of 14 economists surveyed by Bloomberg News expect rates are on hold until the first quarter next year.

New Zealand’s dollar, the worst-performing G-10 currency this year, may fall further on concern the nation will slide into a recession and the prospect that Australia, Korea, the euro area and the U.K. will raise rates this year. Bollard said the economy may contract in the first quarter as the aftermath of the magnitude 6.3 quake in the nation’s second-largest city on Feb. 22 hurts consumer confidence and spending.

“The fact that absolute interest rates are 2.5 percent is woeful” for the currency, said Annette Beacher, head of Asia- Pacific research at TD Securities in Singapore. “We don’t like the kiwi. We pretty much have it lower because the economy is underperforming.”

New Zealand’s currency has slumped 5.7 percent so far this year, and fell as low as 73.36 U.S. cents after today’s rate decision, the lowest since Oct. 1. It bought 73.58 cents at 5:44 p.m. in Wellington.

The Reserve Bank of New Zealand’s reduction in the cash rate was its first since April 2009, when the South Pacific nation’s economy was emerging from a recession during the global financial crisis.

Tightening Policy

The Bank of Korea today raised interest rates for the second time this year after inflation exceeded its target ceiling for two consecutive months. Eighteen of 25 economists surveyed by Bloomberg News expect Australia will raise its benchmark rate in the second quarter.

China has raised rates three times since mid-October and a Feb. 15 report showed the nation’s inflation exceeded the government’s 2011 target for a fourth month, escalating pressure on the central bank to keep increasing borrowing costs.

European Central Bank President Jean-Claude Trichet said last week he may raise borrowing costs from a record low after inflation quickened above its limit to 2.4 percent.

Investors predict the Bank of England will boost borrowing costs to 0.75 percent in June from 0.5 percent and to 1 percent in October, according to forward contracts on the sterling overnight interbank average compiled by Tullett Prebon Plc.

Relative Rates

When asked about the effects of his rate cut on the local dollar, Bollard acknowledged that New Zealand’s interest rates are low compared with the world’s major economies.

“It’s hard to say we’ve got high interest rates in New Zealand now compared to the” countries in the Paris-based Organization for Economic Cooperation and Development, Bollard said today during testimony to parliament’s select committee in Wellington.

Still, Bollard’s pledge that the rate cut will be reversed when post-earthquake construction begins to fuel economic growth may slow the currency’s decline, Beacher said. “The Reserve Bank has pretty much promised the next move is up, and that might keep a floor under the currency for longer,” she said.

Last month’s temblor struck Christchurch at lunchtime, wrecking buildings and forcing an evacuation of the central business district. Output from the South Island city, which makes up 15 percent of the nation’s gross domestic product, has slowed as workers left the city and offices were abandoned.

Death Toll

More than 160 people died, making the quake the deadliest since 256 died after a temblor struck the North Island city of Napier in 1931.

“It is clear that economic activity, most certainly in Christchurch but also nationwide, will be negatively impacted,” Bollard said in Wellington earlier today. “Lowering the cash rate should be regarded as an insurance measure, designed to help offset the negative economic effects of the earthquake.”

The economy showed signs of slowing before the February quake, with risks that the nation fell into a recession in the second half of 2010. GDP contracted in the third quarter partly because of a less damaging earthquake in Christchurch in September, and Finance Minister Bill English said last month it was possible it shrank in the three months ended Dec. 31.

“Even before the earthquake, GDP growth was much weaker than expected,” Bollard said, citing weak retail sales, declining housing investment and an early summer drought.

Recession Risk

GDP “held steady” in the fourth quarter of 2010 and the quake likely reduced growth by 0.6 percentage point in the three months through March, making it “quite possible” the economy shrank, the central bank said.

The economy will grow an annual average of 0.9 percent in the year ending March 31, less than the 1.7 percent forecast in December, the central bank said. By March 2012, growth will have improved to 2.7 percent, although that is slower than the 3.4 percent forecast in December.

Rebuilding damaged buildings and infrastructure in Christchurch will boost growth in 2012 and 2013, Bollard said. The cost of reconstruction will be NZ$15 billion ($11 billion), he said.

“With interest rates being one of the main drivers for G-10 foreign exchange at the moment, we expect that the kiwi will remain under pressure,” Win Thin, head of emerging-market strategy at Brown Brothers Harriman & Co. in New York, said in a research note. “It is clear that the RBNZ is likely to remain one of the more dovish central banks.”

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

To contact the editor responsible for this story: Stephanie Phang at sphang@bloomberg.net

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