A sinking feeling? The Official Cash Rate (OCR) drops again

The Official Cash Rate (OCR) continues to drop as the Reserve Bank of New Zealand (RBNZ) announced it fell 25 basis points to 2.25 percent on March 10, 2016.


The OCR – an interest rate set by the RBNZ – principally determines the wholesale price of borrowed money. This directly affects the way commercial banks distinguish the rates they offer their customers.


In relation to the OCR drop, Westpac chief economist Dominick Stephens said a rate cut had been expected, but not so soon. According to Stephens, the key reasons for the cut were concerns over the worsening international economic environment and the recent fall in inflation expectations.


Who does the OCR drop affect?


Essentially, a lower OCR favours borrowers. Low interest rates help to encourage more borrowing and overall spending.


The announcement of a lowered OCR is good news for mortgage holders. When interest rates go down, borrowers will likely pay less money towards their debts. If credit becomes more affordable, borrowing will increase. Savers, meanwhile, miss out as the money they have in their bank accounts and term deposits earns them a lower rate of interest.


A drop in the OCR can also raise share and property prices as they’re often seen as benefiting from the boost to the economy generated by lower interest rates. Although house price inflation in Auckland has cooled down in recent months, house prices remain at high levels and additional housing supply is still in great demand. Housing market pressures have also been building outside of Auckland. During a lower OCR period, the returns on these types of assets generally become more appealing.


The dairy industry, meanwhile, continues to suffer as low global milk prices are generating significant financial pressure for dairy farmers. Nearly one half of the dairy sector is currently experiencing a second consecutive season of operating losses.


What happens if the OCR increases?


When the OCR goes up, savers benefit from a higher rate of return on their money.


Meanwhile, those with debts – borrowers – will see an increase in the amount they have to pay to service their loans. This incidentally leaves less left over from their incomes to spend on other goods and services.


Small change, big impact


For many small businesses – when the OCR rises – the cost of financing their business will typically go up. New Zealand’s trading banks do most of their small business funding using mortgages as security.


For example, a retailer who wants a bank loan to finance their stock will usually have to secure the loan against their house. The retailer’s mortgage finances the business. This means that the cost of financing the business rises and falls as mortgage interest rates rise and fall.


Small-to-medium enterprises (SMEs) have been riding out the effects of the global slow-down a few years ago. As the OCR continues to drop, SMEs start to feel more confident about their growth prospects. This confidence, however, can potentially fizzle out if the OCR suddenly rises; increasing interest rates raise the cost of finance to the business.


Theoretically, a higher OCR can leave less money in the pockets of consumers, so SMEs will see likely see a slowdown in sales.


What’s next?


The RBNZ’s interest rate forecasts point to another 0.25 cut – to 2 percent – this month. A further drop to 1.5 percent can be expected as early as August, according to CBA senior interest rate strategist Jarrod Kerr and senior fixed income strategist Philip Brown.


“The RBNZ’s two downside scenarios, outlined in the March Monetary Policy Statement, show a move to 1.5 percent. The RBNZ’s previous downside surprise scenarios have become central scenarios for the past 18 months. We expect no different this time around. We now see a very good chance that the RBNZ cuts the cash rate to 1.5 percent. The risk is the RBNZ tries to stay ahead of currency markets and cuts consecutively to 1.5 percent by August.”


What’s your take on the OCR? Do you think it will drop down to 1.5 percent? Any insights or perspectives you would like to add? Please email Simon at sdalton@gerryrea.co.nz