By Praveen Menon and Charlotte Greenfield
WELLINGTON (Reuters) - New Zealand's central bank stunned markets on Wednesday by cutting interest rates a steep 50 basis points and even flagged the risk of going nuclear by taking rates below zero, a radical shift that drove its currency to three-and-a-half year lows.
Seemingly trying to get ahead of policy easings in the United States and Australia, the Reserve Bank of New Zealand (RBNZ) slashed its official cash rate (OCR) to a record trough of 1% and opened the door to truly drastic action.
"It is easily within the realms of possibility that we might have to use negative interest rates," RBNZ Governor Adrian Orr told a news conference after its policy meeting.
Markets, which had predicted a 25-basis point cut after a similar sized reduction in May, had not even dreamed that such a move would be needed barring a global recession or a natural disaster, and the impact was immediate.
The kiwi dollar tumbled 2% to $0.6378, its lowest since early 2016 and the steepest daily decline in a year. Yields on two-year bonds sank to just 0.81% as investors priced in the prospect of at least one more rate cut.
Minutes of the RBNZ's meeting highlighted how alarmed they had become by the recent escalation in the Sino-U.S. trade dispute, fearing its deadening impact on investment and growth.
The committee drove home its dovish message by predicting there was no chance of a hike until late 2021, a lower for longer outlook that was also recently adopted by the Reserve Bank of Australia (RBA).
"This was a stunning decision," said Westpac's NZ chief economist Dominick Stephens, noting rates had been cut by 50 basis points or more on only three other occasions. Indeed, the RBNZ last cut by 50bps in 2011 after a devastating earthquake in the city of Christchurch.
"The RBNZ appears to be trying to get ahead of the curve," he added. "Given its clear willingness to reduce rates, and our view that there is some further economic softness to come in the near term, we now expect another 25bp cut in November."
Growth in New Zealand's near $200 billion economy has been running below-par in recent quarters as international trade frictions slowed global demand in a blow to factory activity and exports. Business and consumer confidence have also sunk, painting a gloomy outlook.
OFFENCE BEATS DEFENCE
Policymakers everywhere have been forced to consider more stimulus as fears grow over the broadening fallout of the U.S.-China trade dispute on the global economy.
Last week, the U.S. Federal Reserve cut rates for the first time in a decade, while the RBA eased in both June and July.
Markets are wagering the European Central Bank and Bank of Japan will have to follow or risk their currencies rising to uncompetitive levels.
Investors this week feared Beijing had opened a new front in the currency conflict by allowing its yuan to weaken past 7.0000 per dollar, pressuring competitors to follow suit. Those fears were underscored after Washington labelled China a currency manipulator in a dramatic escalation of the trade dispute between the world's biggest economies.
Governor Orr all but acknowledged the motive for his move by saying the single biggest challenge to NZ policy was how low interest rates were elsewhere in the world.
"Offence is the best form of defence," said Josh Williamson, an economist at Citi. "Committee members were more concerned about global growth headwinds and the potential impact on the New Zealand economy via the trade channel."
Still, there was a chance that front-loading the stimulus would provide just the jolt the domestic economy needed.
Data out just this week showed employment had been surprisingly strong in the three months to June, taking the jobless rate down to an 11-year low of 3.9%.
"A cash rate of 1% for an economy with an 11-year low in unemployment, rising wages and expansionary fiscal policy may remove any downside risk from our 2020 growth forecast," said Williamson.
All that was needed now was for the global outlook to be just a little less dire.
(Reporting by Praveen Menon and Charlotte Greenfield; Writing by Wayne Cole, Editing by Shri Navaratnam)