Can the OCR go negative? Chief economist says yes

by Ksenia Stepanova22 Aug 2019

The Reserve Bank has made two cuts to the Official Cash Rate (OCR) over the last four months, and both cuts saw all major banks respond with full force and drop their mortgage rates accordingly. Another cut has been pencilled in by economists in November - but how much steam are further OCR cuts likely to hold, and at what point does it hit its limit?

Westpac chief economist Dominick Stephens spoke at today’s Financial Advice New Zealand conference in Auckland, where he explored just how low the OCR could possibly go, and what happened when the central rate in other countries dropped beyond 0%.

“I think the Reserve Bank will cut the Official Cash Rate (OCR) once more to 0.75% in November of this year,” Stephens said.

“A lot of people are asking whether the OCR running out of room and effectiveness. They’re saying it’s not affecting the interest rates that matter, and it’s not affecting the economy in the same way that it used to.”

“But to date, the OCR cuts we’ve seen have been incredibly effective,” he explained. “There has been a massive drop in the rates that really matter for the economy, and those are the fixed mortgage rates. The Reserve Bank has engineered that by convincing people that they are going to keep interest rates low for a long time, and so the OCR cuts to date have been incredibly effective. Anyone who says they haven’t been is wrong.”

However, Stephens admits that engineering a second reduction in mortgage rates of that size would require a lot more work from the Reserve Bank, because they’ve already had this large effect on expectations for the future. He says the same effect would be hard to repeat - but it’s not impossible.

“Some are saying that the OCR is nearly at 0%, so what next?” Stephens said. “Well, the OCR can go negative - but there is a limit to how far it can go. In Europe, banks found that they were paying the central bank to hold the reserves that they were required to hold - and that’s a cost to them. In response, they started putting mortgage rates up to recover that cost.”

Stephens recounted speaking to the Prince of Lichtenstein’s private fund, which was looking into the cost of putting cash in a private bunker - and discovered that could cost around -0.75%, the same as the cash rate at the time. So if interest rates went lower than that, they would simply put all their cash into a cave.

“Cash hoarding is really the risk when it comes to negative interest rates,” Stephens said.

“I think the lowest the OCR can go in New Zealand is around -0.5%.”

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