The Reserve Bank surprised markets yesterday by suddenly introducing the possibility of rate cuts, announcing it's next interest rate move could be either up or down.

As expected, the bank kept its official cash rate at 3.5 per cent at yesterday's review but the real news for the market was the bank's comment that it expected to keep the rate on hold for some time.

Following this statement wholesale interest rates fell, which is expected to reinforce a decline already under way in fixed mortgage rates. Faltering growth internationally combined with a collapse in oil prices (60% since the middle of last year to a six year low), has resulted in a strong ebb tide running in interest rates.

The central bank has not switched from a tightening bias to an easing one. Its new stance is, in the words of Westpac chief economist Dominick Stephens, "deadpan neutral". But the financial markets don't do neutral. They are binary: If the interest rates are not heading up, they must be heading down.

"The Reserve Bank has effectively thrown its hands in the air and given the market the green light to respond to the data-flow as it sees fit," said ANZ chief economist Cameron Bagrie.

The Bank of New Zealand's head of research, Stephen Toplis, said yesterday's review of the OCR was a test of what the Reserve Bank was more concerned about: the ongoing strength of the New Zealand dollar or a housing market threatening to get out of control again. Toplis concludes that it is the dollar and that the bank is prepared to take a "premature gamble" with the housing market.

In its December statement the Reserve Bank was still sanguine about the risks of house price inflation, forecasting less than 5 per cent per annum nationwide over the next three years. More recent data will have challenged that view and it now acknowledges the housing market is "showing signs of picking up, particularly in Auckland".

The New Zealand dollar dropped by more than US1c after the Reserve Bank abandoned its previous tightening bias and left the door open for future interest rate cuts.

There has been no change to the OCR rate since July 2014

Source: WSJ.com, NZ Herald