OREANDA-NEWS. The decision by the Reserve Bank of New Zealand (RBNZ) to cut the official cash rate to a record low 2.25% yesterday, should help to support growth, households' debt-servicing and banks' retail loan asset quality, says Fitch Ratings. That said, a low-interest-rate environment will eventually hurt bank profitability. Fitch still expects broader asset-quality weakening in 2016 as low dairy prices will continue to add to pressures on farmers - especially as dairy cooperative Fonterra revised down its 2015/2016 milk price forecast on Tuesday.

The rate cut should put downward pressure on the NZD/USD exchange rate, helping to spur growth in service exports and supporting employment. It will also particularly benefit households - in light of high household debt, and stagnating house-price growth in Auckland. Residential mortgages dominate New Zealand banks' household exposure, and the improved serviceability that will come with low rates should help to maintain asset quality for this sector in the short term.

But monetary policy loosening will not be sufficient to alleviate all of the macro pressures facing the banking sector. Notably, the weakening in asset quality that Fitch expects in 2016 will be primarily driven by dairy.

Agriculture is the largest industry segment for the large banks ANZ Bank New Zealand, ASB Bank Limited, Bank of New Zealand and Westpac New Zealand. Lower rates should help farmers to an extent by improving their debt-servicing position. But the direction of dairy prices remains a much more significant factor for asset quality in this sector than interest rates. Fitch continues to highlight that protracted low dairy prices would weaken banks' overall asset quality while weighing on GDP growth. If dairy prices do not recover, interest-rate cuts are only likely to delay the rise in risks to banks that will come through their agricultural exposures.

Lowering rates could also test new macro-prudential measures put in place by the RBNZ in November which targeted investor mortgages in the Auckland region. Almost 40% of all house sales in Auckland are to investors, and persistent high growth in house prices through to 2015 has made affordability a significant problem in the city and a potential risk for New Zealand banks. The Auckland exposures are well-managed by the banks, however, with serviceability of borrowers measured at a minimum interest rate well above current fixed-rate mortgages.

New Zealand banks benefit from strong deposit franchises, but are still more reliant on offshore wholesale funding relative to international peers, and persistently low interest rates could lead to depositors seeking alternative investments with higher returns. This could contribute to banks needing to increase their focus on long-term wholesale funding at a time when borrowing costs in international markets are rising - thus affecting banks' long-term profitability further.

New Zealand's banks will continue to benefit from strong franchises, parent support and generally stable funding profiles despite the ongoing challenges from the macroeconomic environment. Banks are well capitalised - sufficient to withstand significant losses that would be caused by a major shock in either the housing or dairy sectors - and should be strengthened by continued issuance of hybrid issuance in FY16. Each of the four major New Zealand banks are rated 'AA-/Stable'.