COVID-19 has caused widespread disruption across global markets resulting in job losses and economic hardship. In response, countries across the globe have been implementing economic policy to soften the blow of the current crisis. In New Zealand, the Reserve Bank’s response was swift, immediately lowering the OCR from 1% to 0.25%, and announcing (what would become) a NZ$100B bond buying programme. These measures were considered necessary to lower borrowing costs and to achieve the banks inflation and employment targets.

Acknowledging that further monetary stimulus would be required, the RBNZ asked trading banks to prepare for alternate monetary policy including negative interest rates and a funding-for-lending programme (FLP). Trading banks were advised to prepare for these policies before year end with the Reserve Bank recently announcing that the FLP would commence in December 2020. Property finance companies geared up for change. Investors wait for what the end of the year would bring.

Below we explore these new policies and how they may impact New Zealand households and businesses – the future on which New Zealand’s economy now relies upon.

How do interest rates impact economic activity?

New Zealand businesses and consumers are the lifeblood of our economy – they are what will keep the country’s economy turning. However increased uncertainty may lead many people to sit on the side-lines, deferring consumption and investment decisions until a more certain future is evident. This decline in economic activity threatens jobs and creates deflationary pressures on pricing. To mitigate these risks, lower retail interest rates are needed to stimulate economic activity – where lower rates would reduce funding costs and improve cashflow for households and businesses.

The Reserve Bank cannot directly control retail interest rates – they only influence wholesale rates. Trading banks hold deposit accounts at the Reserve Bank, where the Official Cash Rate (OCR) is the interest rate the Reserve Bank pays trading banks on their deposits. When the OCR is moved down, it reduces a banks cost of funds. The flow on effect to retail interest rates is simply a result of open market competition amongst the various trading banks.

With the OCR at just 0.25%, the RBNZ has little room to lower it further – hence the need for the RBNZ to explore a negative OCR.

How would Negative Interest Rates work?

A negative OCR simply means that banks would be charged to hold cash on overnight deposit accounts. This would incentivise banks to lend or invest their funds in order to avoid paying a holding cost, providing stimulus to the economy. In this sense, a negative OCR influences economic activity with the same strength as a positive OCR.

For household and businesses, lending and deposit rates would decline but do not expect to see them go negative. Retail mortgage rates are set based on a margin, in accordance with funding requirements and broader risk assessments. This margin would be applied to lending to ensure that retail mortgage rates remain above zero. For deposit rates, they will get near to zero but there is a limit as to how low they can go – the closer to zero deposit rates get, the less incentive customers have to deposit funds with a bank. This is an important consideration as deposits are a critical source of funding for banks.

Will the RBNZ move into negative territory?

The New Zealand economy has been surprisingly resilient across key measures of employment, household spending, GDP, and asset prices. The housing sector in particular has performed exceedingly well, with the RBNZ now expecting house prices to increase by 10% for 2020. A complete reversal from the 10% decline predicted earlier this year. With this in mind, the likelihood of the Reserve Bank adopting negative rates is slim.

For now, its priority is on implementing its funding for lending programme (FLP) which will see the Reserve Bank offer low-cost, secured, long-term funding for banks to on-lend to retail customers. Doing so will lower retail interest rates (in a similar manner to a negative OCR) without putting bank deposit funding at risk. The programme will be rolled out in December 2020 and the Reserve Bank expects the size of the programme to reach NZ$28B.

What does this mean for you?

We are entering unchartered territory so it would be amiss to state that anyone knows how this will play out. One of the reasons the Reserve Bank is looking to deploy unconventional monetary policy is because risk factors that threaten to undermine its employment and inflation targets remain present. The economic downturn has not been felt equally by all New Zealand businesses and future growth remains contingent on further stimulus. Current policies continue to point to lower interest rates which should put a floor under asset prices, particularly within housing (with upside potential). Substantial demand remains across both the investor and owner-occupiers’ sectors, and we expect the low interest rate environment to compress yields across the board.

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