The Reserve Bank has slashed official interest rates an unprecedented 1 percentage point to 6.5 points, opening the way for cuts to mortgage rates but also highlighting the grim outlook facing the global economy.
"Ongoing financial market turmoil and a deteriorating outlook for global growth have played a large role in shaping today's decision," bank Governor Alan Bollard said.
As a result of international developments, economic activity in this country would be even further constrained than the bank was expecting just last month, Dr Bollard said.
"New Zealand can expect to face lower demand for exports and credit is likely to be less readily available."
Dr Bollard is currently holding a press conference. He said that the bank had "front-loaded" some of the expected interest rate cuts. Today's cut was big, but people should not "build in" any expectation of future cuts of such a magnitude.
Dr Bollard has emphasised that, while the bank expected to lower the official cash rate (OCR) further, the timing and extent of reductions in the coming months would depend on evidence of reductions in domestic cost pressures as well as on how global financial developments played out.
Council of Trade Unions economist Peter Conway said the full percentage point drop was no surprise.
"But I was hoping he might be a bit more dramatic and go all the way down to six," Mr Conway said.
He said the Reserve Bank did not move earlier because they wanted to separate the issues of credit liquidity and monetary policy.
"And secondly, they didn't believe there was any need to panic in the New Zealand context," Mr Conway said.
He said the Reserve Bank believes inflation is now on its way down with oil and food prices dropping.
Mr Conway said banks have no excuse not to pass on the full percentage point to mortgage holders. He said for home owners on a $200,000 mortgage, that would mean a saving of about $32 a week.
"They [banks] will say there is more of a pure market operating here and just as they were able to borrow low and avoid high interest rates locally, now as they come down, they're still facing high costs borrowing off-shore so it's the flipside," Mr Conway said.
Coming during an election campaign, political reaction to today's interest rate cut has been swift.
New Zealand First leader Winston Peters, in a statement just released, said the bank "should have been bolder" and cut the OCR by 1.5 per cent to "relieve serious damage to the economy".
"While this mornings cut is a reasonable first step, it is too little, too late," said Peters.
"Other countries have slashed their interest rates substantially in recent weeks. Our Reserve Bank has twiddled its thumbs while jobs are lost, businesses have gone broke and families lost equity in their homes," said Peters.
"The loss of home equity is particularly distressing for many - figures in this morning's paper show an estimated 130,000 homeowners now have homes valued at less than what they owe their bank. The Reserve Bank should have cut the rate earlier to ease the burden for people in such a situation.
Peters said he hoped the trading banks passed on the full effects of the cut to struggling home owners and did not use the credit crunch as an excuse to add to their "already obscene profits."
The size of today's cut had been widely expected by economists and the market, despite figures earlier this week showing the annual inflation rate hit an 18-year high of 5.1 per cent in the September quarter.
The Reserve Bank is required to keep inflation within 1-3 per cent over the medium term, and today Bollard said it now expected the inflation rate to return to the target band around the middle of next year.
Despite that, the bank was concerned that domestically generated inflation, particularly in labour costs, local body rates, electricity prices and construction costs was remaining stubbornly high.
Dr Bollard said consumers and businesses were likely to be more cautious and curtail spending in the current economic environment.
But the reduction in domestic spending would be partly offset by the depreciation of the New Zealand dollar in the past few months, falling oil prices and the recent loosening of fiscal policy.
Six weeks ago, Dr Bollard surprised with a larger than expected 50-basis point cut in the OCR, as he started to bring forward the planned easing cycle to give some relief to businesses and consumers.
The OCR had been held at 8.25 per cent for a year until easing started in late July, while the economy sank into recession in the first half of the year.
Source: NZ Herald