Groundwork shows Reserve Bank getting more serious about negative OCR

Thursday, 13 August 2020

Reserve Bank governor Adrian Orr has said the OCR is on hold until March, but expectations are growing they will then go negative.

The Reserve Bank is laying more groundwork for cutting the Official Cash Rate below zero.

Cutting the OCR below zero would benefit borrowers including homeowners who could see mortgage rates fall by up to about 1 per cent, at the expense of savers who have already seen interest rates on term deposits and other cash savings hammered.

At the same time as raising the cap on quantitative easing from $60 billion to $100b on Wednesday and extending the programme by more than a year to June 2022, the central bank said it could also directly fund bank lending.

Commenting on its latest monetary policy statement, assistant governor Christian Hawkesby made it clear the Reserve Bank believed it might need to help fund bank loans to ensure they were able to pass on the benefit of a negative OCR to borrowers.

What does the official cash rate mean?

* Reserve Bank expands cap on quantitative easing to $100 billion

* Raising cap on money printing to $100b and buying US bonds tipped as options for Reserve Bank

Without such intervention, banks might be constrained from passing on a rate cut, he said.

That was because there might be a limit on how low they could let term deposit rates fall while still attracting the volume of savings required to finance their loan books.

“Where our thinking has developed, is that it is how you use those tools in combination that matters,” Hawkesby said.

“If we move the OCR lower and banks’ funding costs don’t change, they aren’t able to pass on the cut in the OCR.

Reserve Bank assistant governor Christian Hawkesby says the bank’s thinking has evolved on how to use stimulus tools in tandem.

“What having a ‘funding for lending scheme’ does is say to the banks ‘look, we are going to help you lower your funding costs – you give us good quality collateral and we will give you very low-cost funding’.”

Banks could then have more confidence lowering term deposit rates as they would have an alternative funding source, he said.

The Reserve Bank has asked banks to update their system to allow for a negative OCR by the end of this year, though governor Adrian Orr has given the bank’s word to keep the rate at 0.25 per cent until March.

Its previous research has suggested rates could be cut to about -0.75 per cent before other difficulties emerged.

It would take a little bit of time for economists to absorb the Reserve Bank’s monetary policy statement “and start to revise the probability of us moving the OCR negative”, Hawkesby said.

The Reserve Bank has not ruled out directly funding bank lending prior to cutting the OCR below zero, but Hawkesby agreed he was not talking up that possibility.

New Zealand’s fresh outbreak of Covid-19 has had only a “reasonably modest” impact on financial markets so far, he said.

“I think the market is still trying to digest that news and doing it in the context of a lot of ‘noise’ globally.

“We are seeing some downward pressure both from the news of the outbreak and from our stance, but that is within the context of a lot of volatility globally.”

The Reserve Bank’s new budget and timeline for QE means the programme would need to taper-off before its new end date of June 2022.

But Hawkesby indicated that the cap on QE could be increased again if the economic situation deteriorated and forced the Government to issue unexpected additional debt.

The Reserve Bank’s spending on QE was constrained by its desire to ensure there was still a healthy commercial market for government debt, which limited the proportion of government bonds it could buy.

Increasing the cap now would prevent any risk of a “cliff edge” in the next few months that markets might start to price in, he said.

“That kind of focus can lead to yields rising – we want to take that off the table.”

The Reserve Bank has increased its weekly spend on quantitative easing from about $900m a week to $1.1b, reflecting its new assumption that New Zealand’s borders are likely to remain closed until the end of next year and that economic risks are “on the downside”.

Hawkesby said the increase in the weekly QE spend was done “deliberately to provide more downward pressure on yields and we are willing to look at that again”.

While it decided its spend on QE week by week, “certainly the intention is to run at a faster average pace than we were before”, he said.