'No change': Reserve Bank holds Official Cash Rate, but economists expect it to go negative

Reserve Bank Governor Adrian Orr
The Official Cash Rate will remain at 0.25 percent - for now. Photo credit: Supplied.

The Official Cash Rate (OCR) remains at 0.25 percent, the Reserve Bank has announced.

But economists say the record-low cash rate hasn't hit the bottom. They expect the OCR to be cut as much as 75 basis points by mid-2021.

In a statement released on Wednesday, Reserve Bank Governor Adrian Orr confirmed the decision to leave the Official Cash Rate where it is.

"The Official Cash Rate (OCR) is being held at 0.25 percent in accordance with the guidance issued on 16 March," Orr said in a statement.

"The Monetary Policy Committee agreed to continue with the Large Scale Asset Purchase (LSAP) Programme up to $100 billion. This action is necessary to further lower household and business borrowing rates."

The central bank said it's clear more stimulus will be needed. A bank funding for lending programme will be ready by the end of the year. Other policy tools it's prepared to use include purchases of foreign assets and a negative cash rate.

Economic activity remains well below pre-COVID-19 levels. Commodity prices are robust, partly offset by the exchange rate. Border restrictions will impact migration and tourism. Wage subsidies are now closed to new entrants.  

"In line with the weak underlying international and domestic economic conditions, the Committee expects a rise in unemployment and an increase in firm closures, as resource reallocation continues," he said.

The OCR was last cut by 75 basis points in March. In August, the Reserve Bank extended the limit on the Large Scale Asset Purchase (LSAP) programme to $100 billion, in the aim of lowering retail interest rates. It involves buying Government Bonds, Local Government Funding Agency Bonds and NZ Government Inflation-Indexed Bonds in the secondary market by June, 2022.

ANZ said slow economic recovery and rising unemployment are likely to prompt the Reserve Bank to introduce other tools as the LSAP programme reaches its limit. The bank is currently forecasting a 50 basis point cut in April, to -0.25 percent.

Kiwibank chief economist Jarrod Kerr said the Reserve Bank seemed set on a negative cash rate. Although it committed to keeping the cash rate at 0.25 percent until March 2021, the best 'bang for buck' would be a 75 basis point cut in February, to -0.5 percent. 

"[It] would deliver not only a massive drop in market interest rates, but a significant currency decline (at least temporarily)," Kerr said.

Retail interest rates aren't expected to fall below zero. But under a -0.5 OCR, bank deposit rates would likely fall below 1 percent, and mortgage rates below 2 percent.

In Kerr's view, a negative cash rate puts unnecessary strain on the financial system and increases savings. This is contrarary to what the Reserve Bank is trying to achieve, which is to increase spending and investment, to stimulate the economy.

Negative Government bonds would mean having to pay to own Government debt. Bank profitability, superannuation, ACC and insurance companies would likely come under pressure to accumulate assets. Savers would have to strive harder.

"They'd have to go into riskier assets...NZ Super is going to have a tougher time building a pot to pay pensions.  It's not a free hit," he said.

As part of a 'stress test' on banks' resilience during COVID-19, the Reserve Bank confirmed that under a pessimistic scenario of a 24 percent fall in June 2020 GDP, 13.4 percent unemployment and a 37 percent fall in house prices, banks could draw on capital and keep lending.

REINZ figures for August show a 16.4 percent rise in the national house price year-on-year. A stronger housing market may indicate stronger recovery in spending and construction. However the Reserve Bank also noted that low population growth and rising unemployment would likely constrain further house price increases. This is in line with Treasury's PEFU report forecast of a 5.1 percent fall by June next year.

The Reserve Bank will next review the Official Cash Rate as part of it's Monetary Policy Statement on November 11.