The Reserve Bank of New Zealand sets monetary policy by controlling the Official Cash Rate (OCR), which it reviews eight times a year (it can make unscheduled adjustments, but that doesn’t happen often).
The OCR can affect interest rates and any changes to the OCR usually has flow on effects for banks, people with home loans or savings accounts, pretty much anyone who has, or wishes to have, two cents to rub together.
This week, the Reserve Bank will make its seventh OCR announcement for 2015.
Price of $
The OCR sets the price of overnight money for banks to deposit with the Reserve Bank (they pay the OCR on banks’ excess funds). The current OCR rate together with the market’s view on future changes to the OCR rate combine to form the interest rate curve for the short to long-term (1 day to 10 years and more).
In general, the OCR and the market view on future OCR movements is what drives interest rates for banks and customers.
Following Reserve Bank meetings to review the OCR, it provides the market with guidance on what factors could lead to rate changes in the near future. It is this guidance, along with any actual changes to the OCR, that affects the rates at which banks can borrow and lend.
Here’s a practical example:
On 10 September 2015, citing “softening” in the economy and a need to keep inflation on target, theReserve Bank cut the OCR by 25 basis points (a basis point is a common unit of measure for interest rates and other percentages in finance, and is equal to one hundredth of a percentage point, e.g. 25 basis points = 0.25 per cent).
In response, a team of specialist BNZers gathered together to decide what that meant for interest rates. They decided to cut 25 basis points from Standard, Rapid Repay and Mortgage One variable home loan interest rates in this case (the OCR is just one of many factors banks consider when making pricing decisions).
The bank’s TotalMoney variable rate was also reduced by 10 basis points (0.10 per cent), making it the lowest floating rate in market among the four major banks.
Predicting the future
The next OCR announcement is on Thursday and speculation is fairly united with most economists expecting the OCR to be unchanged.
And, how about next year?
BNZ Chief Economist, Tony Alexander, says few forecasters around the world have got their interest rate predictions right since 2007, so borrowers and savers should be very careful not to make decisions highly dependent upon a particular set of interest rate forecasts proving correct.
“Having said that, in a world of low inflation and deepening worries about deflation, an increase in the OCR is not likely over 2016. A decrease is also not highly probable given the recent rebound in dairy prices, booming construction, and still rising net migration inflows to New Zealand,” says Tony.