The term official cash rate (OCR) is used used in Australia and New Zealand for the bank rate. It is the most important monetary policy tool available with the central bank. It denotes the interest rates set by the central bank and defines the wholesale cost of borrowed money. It is implemented by the retail banks and reflects in the rates charged by these banks from their customers for borrowing --whether it is mortgages, loans or credit cards. This wholesale rate also determines what the banks will pay for term deposits or saving account to their customers.

The rate is set regularly by the central banks. In Australia the central bank is known as the  Reserve Bank of Australia (RBA) and in New Zealand it is known as the Reserve Bank of New Zealand (RBNZ). The main purpose of OCR is to meet the inflation target specified in the Policy Targets Agreement. According to the current target agreement the stability is defined as annual increases in the Consumer Price Index (CPI) of between 1 and 3% over the medium-term.

History of OCR?

 The OCR was introduced in March 1999 and is reviewed eight times a year by the Bank. Out of these, Monetary Policy Statements along with OCRs are announced four times in a year. It is made every quarter. The central banks are not obliged to change the rates if they are satisfied with the stability quotient of the country.

How does the OCR have an impact on average Kiwi?

A low OCR favours borrowers. When there is low OCR, the interest rates are slashed by the commercial banks and credit becomes cheaper for the customers.   Credit becomes more affordable as a result there is more borrowing.

While a low OCR fuels more demand and spending, on the other hand it leads to people earning less on their term deposits and savings accounts due to low interest rates.

The reverse happens when the central banks increase the OCR. Savers benefit from higher rates on their term deposits and savings.  Meanwhile, those the cost of borrowing becomes expensive so there is less demand and inflation comes down due to less demand in the economy. The amount that the customers have to pay to pay their loans leave less left over from their incomes to spend on other goods and services.

What moves the Reserve Bank to change OCR

The main goal of the central bank is to maintain price stability by keeping the inflation targets in the range of 1 to 3%.   By changing the bank rates from time to time the Reserve Bank is trying to balance out inflation and supply and demand. It influences the banks to charge higher or lower interest rates on loans and also what they pay to the depositors. Reserve Bank basically influences the way people and companies borrow, save and, therefore, spend.

So using interest rates as a tool to keep inflation under control is what the Central bank does from time-to-time.    If the inflation is in the target zone, the central bank doesnot need to change or tweak the interest rates, but if the inflation is moving northwards, the Reserve Bank increases the OCR. This puts a brake on the spending and makes saving more attractive than spending.  But if the inflation rate falls below the target then the Reserve Banks has to lower the OCR encouraging more borrowing, spending and boosting the economy.

What impact can OCR changes have?

When OCR is decreased, its impact is felt in several ways.  It lowers the interest earned on short-term deposits which makes investment less attractive as compared to overseas deposits, resulting in a dip in the lower demand for Kiwi dollar and a depreciation in the currency. It makes the long-term fixed interest deposits more attractive, so the price for long-term bonds may increase, resulting in capital gains for those who are invested in these assets.

A lower OCR can give a boost to the property prices as lowered interest rates always make investments in property very attractive. Even the stock market gets a boost. People prefer to invest in stocks as the interest on their fixed deposits reduces.  So a different asset class gets a boost as compared to fixed deposits.

However, a change in OCR is not always predictable. The main reason may not be inflation alone, it can be other domestic and international reasons like the overall economic situation and the expectations of the investors, thereof.

Also the responses to OCR changes may not be predictable and the NZ dollar may rise and For example, a cut in the OCR may result in a higher New Zealand dollar and lower demand for  long-term bonds If it is lowered more than expected or seen stoking inflation more than the target rate.

Are interest rates in New Zealand moved only with OCRs?

OCR is one of the key factors that decides the interest rates in Australia and New Zealand, but it is not the only factor. The other factor is also the interest rates that New Zealand banks pay to borrow from the offshore markets to fund their home loans.  The interest rates can often change due to these borrowings which might be short-term. In the long to medium-term it is the OCR that determine the interest rates of the country.

In case of unexpected events, there can be unscheduled OCR adjustments. It has done so in the past on occasions such as bombing of World Trade Centre in September 2001.  Reserve Bank  may increase or decrease the OCR to keep the economy in place and minimizing the impact of the particular event.