By Charlotte Greenfield and Rebecca Howard
WELLINGTON (Reuters) - New Zealand has joined Australia in cutting interest rates to record lows to stave off deflation and to restrain rising currencies, but a rapid descent to zero rates is bedevilled by solid economic growth and hot housing markets.
The Reserve Bank of New Zealand (RBNZ) cut rates by 25 basis points to 2.0 percent on Thursday while Australia cut rates to an all-time low of 1.5 percent early this month.
The RBNZ's challenges became immediately apparent after the central bank decision, with investors lifting the local dollar to a one-year peak despite the easing and threatening to depress both exports and inflation in New Zealand's small open economy with a population of 4.7 million.
The Australian dollar also proved to be extremely resilient after the RBA decision. In both cases, markets wanted more and were disappointed.
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"Central banks are 'reluctant cutters' as they head towards lower bounds," said Jarrod Kerr, a senior interest rate strategist at Commonwealth Bank of Australia.
"Frustrations over currency strength and inflation expectations eventually overpower policymakers because it is a global theme and a theme the RBNZ cannot escape," said Kerr, predicting rates might have to halve to 1 percent in time.
New Zealand and Australia, however, are global outliers given the negative interest rates operating in countries that represent a quarter of world output.
In such an environment, the RBNZ had to ease just to stop its currency from rising and further depressing inflation, said Wheeler.
The battle against excessive currency strength, however, is not going well. On Thursday investors pushed the kiwi dollar up over 1 percent to a high of $0.7351 >, underlining just how daunting a challenge the RBNZ faces.
Consumer price inflation is running at just 0.4 percent, well below the RBNZ's target range of 1 percent to 3 percent.
Wheeler said the bank would do what was necessary to get inflation back in the target range and left the door wide open for additional stimulus.
"Our current projections and assumptions indicate that further policy easing will be required to ensure future inflation settles near the middle of the target range," he said in the bank's August policy statement.
Assistant Governor John McDermott told Reuters that one more rate cut was likely with another possible. "The market has figured out appropriately that we have a big chance in November to assess where we've got to," McDermott added .
However, the RBNZ's cut on Thursday looked weak compared with the Bank of England's policy easing last week, which included a 25 basis point cut and a stimulus scheme worth as much as 100 billion pounds to ensure the cut reaches households.
Both Governor Wheeler and RBA Governor Glenn Stevens, however, have expressed their reluctance to cut hard.
Earlier this week Stevens said there were limits to what monetary stimulus could achieve, including "dialling up" economic growth or pushing inflation higher in short order.
In particular, Stevens downplayed concerns the RBA might take excessive policy measures to push inflation back into its 2 percent to 3 percent target range "in short order."
Wheeler was also clear.
"You have to think about what life is like in an economy that is likely to grow at around 3.5 percent if you suddenly race to the bottom with interest rates," he told a parliamentary commission.
In New Zealand, booming housing prices, the second fastest-growing in the world after Qatar, according to the International Monetary Fund, add to the pressure.
"Just think what the housing market would be doing if we race to the bottom and use up all our capacity on monetary policy," he added.
New Zealand's central bank recently announced new macro- prudential tools aimed at curbing high-velocity house price growth.
(Reporting by Rebecca Howard; Editing by Sam Holmes and Eric Meijer)
Disclaimer: No Business Standard Journalist was involved in creation of this content
