October OCR announcement - what the first Official Cash Rate increase in over seven years means for you

On 6 October, the Reserve Bank of New Zealand (RBNZ) released its Monetary Policy Review, announcing an increase in the Official Cash Rate (OCR) from 0.25% to 0.5%. What will this mean for you?

The Official Cash Rate, or OCR as it’s usually referred to, was cut to just 0.25% in March 2020 - the lowest it’s ever been. For a few months back in 2020, economists were warning the OCR could go to the unprecedented rate of zero. There was even talk of it going into the totally uncharted territory of a negative rate, as we have seen in Europe and Japan.  As the economy has recovered, the need for extremely low interest rates has reduced, and the process of raising the OCR has begun.

So, what is the OCR? What does it do? And why did the Reserve Bank lift it today?

See more of ASB’s latest financial news and announcements here on our blog.

The OCR is one of the key levers that the RBNZ can use to influence the economy.

The OCR sets overnight interest rates banks pay, that in turn influences short term funding costs in the New Zealand economy. The expectations of what the Reserve Bank is going to do with the OCR influences New Zealand’s longer term interest rates.

The Reserve Bank reviews the OCR seven times each year, to make sure it’s at the right level. The Reserve Bank often leave it “on hold”, as we have seen at each meeting since March last year. When it is adjusted, it is usually done in 0.25% increments, as we saw this month. But occasionally the RBNZ makes larger adjustments.

In its October review, the RBNZ did what we expected it would do: increase the OCR by 0.25%.

This was also expected in financial markets; and furthermore, economists and analysts have already been talking that this is the start of a rising period for interest rates.

ASB expects more OCR increases over the year ahead; we think the OCR will rise from its new setting of 0.5%, to 1.5% by the end of 2022.

For the last few months, longer term fixed mortgage rates have already been lifting in line with wholesale interest rates. These are the rates banks pay to raise money in the wholesale markets, which when combined with term deposits, provide the majority of funding for home loans.

Now that the October OCR increase is confirmed, and more increases are expected, it is likely to maintain the upwards pressure that have been on long term fixed mortgage rates all year, and could well lead to short term rate increases, including the variable mortgage rate.

As anyone living off a lump sum of savings knows, over the last year term deposit and savings rates have been super low. In fact, they’ve been the lowest we have on our records going back to the 1960s.

But 2021 has been a turning point. Term deposit rates have started to increase, at last. The five-year term deposit rate has more than doubled, from 1% to over 2% (at the time of writing). But while any increase in interest rates is good news for savers, the rates for term deposits and savings accounts are still lower than what most people think of as “normal”, and we expect rates to remain low when compared to the average levels over the past 10-15 years.

One of the biggest challenges for people is the inflation rate. We expect inflation will be much higher over the next five years than it has been over the past five years. Inflation is now back above 3%, and we expect it to press higher over late 2021/early 2022.

That means it’s decreasing the value of your money faster than the interest rate is growing it in a term deposit.

If that continues to be the case, the higher expected returns of managed funds and other investments will continue to be more attractive to savers.

KiwiSaver and investment funds providers offer a range of choices to investors.

Most of those choices fall on a risk spectrum, where customers can choose low risk and low returns, or higher returns with higher risk.

The low-risk options are weighted towards cash and income assets: things like government bonds and other fixed income investments. These investments are impacted by the changes in interest rates both here and offshore that have been occurring.

The “growth assets” like property and shares are influenced by the broad economic backdrop and that includes interest rates.  The low interest rates both here and abroad have been very positive for shares and property over recent years, including the past 12 months.  Related to this, when interest rates change, it can lead to volatility (ups and downs) in sharemarkets and property markets.

However, this doesn’t mean you have to do anything with your investment. These types of changes are always considered by investment managers.  If you’ve taken the time to make sure you are in the right fund or investment to meet your goals, you shouldn’t need to change your strategy.

See our Investor Hub for market commentary and the latest investment insights.

You can subscribe to our economists’ regular interest rate reports, or read them online:

• The ASB Home Loan Report
• The ASB Term Deposit Report
  
• The ASB Economic Newsletter
• And for a global outlook, our investment partners at BlackRock recently released their midyear outlook for the world economy.