In broad terms, the official cash rate determines how much banks pay for their short-term borrowing from the Reserve Bank.
Most of the banks have an account with the Reserve Bank, which they use to send money to other banks when their customers make transactions. When they borrow money overnight from the central bank, they pay the OCR plus a small margin.
This sets a floor under what they then charge borrowers for their loans. To make money from a home loan, for example, lenders take that “wholesale” rate charged by the official cash rate and add a margin.
On top of this, home loan interest rates are also affected by the cost of offshore borrowing and the rate that banks have to pay to attract depositors, but the OCR has particular influence on short-term fixes.
The Reserve Bank's Monetary Policy Committee meets seven times a year to decide what to do with the rate. They look at things like the current rate of inflation, unemployment and the performance of the economy generally to determine what the rate should be. Generally, a rate is described as “neutral” (where it has no effect on activity), “above neutral” (when the RBNZ is trying to calm things down), or “stimulatory” (when the RBNZ wants to lift activity).
Because the OCR plays a part in determining the cost of borrowing for households and businesses, it can have a big impact on the economy.
When the Reserve Bank is worried about inflation getting too hot, it increases the OCR, which means borrowers have to pay more to service their debt and have less available cash to spend on other things which drives up prices.
There is a bit of a lag effect from a household perspective because most New Zealand borrowers with a home loan are on fixed rates, so changes to the official cash rate can take a while to flow through – usually up to 12 to 18 months. At the moment, about half of all home loans are yet to roll off on to the new, higher rates.
If you're a homeowner, it's worth keeping an eye on what's happening with the OCR.
Your home loan will come up for refixing at regular intervals, and it may be helpful to understand the direction rates are heading, so that you can determine the next steps.
You may be wondering what an appropriate strategy may be in a rising interest rate environment: a short-term fix, longer-term option, or something in between? If you want to chat through your options, or need more information to help you understand the factors at play at the moment, get in touch today. We’re here to help.
Disclaimer: Please note that the content provided in this article is intended as an overview and as general information only. While care is taken to ensure accuracy and reliability, the information provided is subject to continuous change and may not reflect current developments or address your situation. Before making any decisions based on the information provided in this article, please use your discretion and seek independent guidance.
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