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Interest Rates in New Zealand

Written by: David Weusten

Article Overview: What drives Interest Rates in New Zealand

Interest Rates in New Zealand

Interest rates have a significant impact on all sectors of New Zealand because of their effect on our economy. A significant factor that causes interest rates’ changes here in New Zealand is our foreign currency exchange rate (cost of the New Zealand Dollar expressed in other currencies). As the NZD is floating against a basket of world currencies (USD, GBP, JPY, Euro) known as the TWI (Trade Weighted Index) the pressure to increase or decrease our interest rates fluctuates daily.

 The New Zealand dollar floats against a basket of currencies.

A few years ago The Reserve Bank used what was called the MCI (monetary control index) to control the economy. It required balancing the exchange rate against interest rates, which meant if one went up the other had to go down. The MCI could be considered New Zealand’s economic accelerator, if the TWI went down it meant New Zealand exports were cheaper so demand for our product increased and this stimulated the economy, so interest rates had to go up to put a break on the economy (because of the fear inflation would get out of control).

 The lower the New Zealand dollar the cheaper our exports are to the world.

New Zealand experienced considerable fluctuations in interest rates in the early 80’s and home loan interest rates got as high as 21 % during this time. It is no wonder that a much greater percentage of Kiwi’s now embrace fixed rates than our Australian cousins do.

Gross Domestic Product (GDP) is the index by which the speed of growth in the economy is measured and inflation could be likened to the wind friction the economy is pushing into. If we had GDP growth of 4 % (comparatively very strong growth) and inflation of 3 % New Zealand’s economy will have grown only a net 1 %, yet the economy will be working very hard to more or less stay still. New Zealand has suffered high levels of inflation over the last 30 years, which has pushed up prices but not added any real value to the economy. This has in fact held New Zealand back in comparison to countries we were once considered ahead of in the standard of living stakes.

 GDP is a measure of New Zealand economic performance.

This history of high inflation in New Zealand and its negative impact on New Zealand’s economy has led to the Reserve Bank being given the major task of keeping inflation between 1 – 3% p.a. As the MCI proved less than ideal, the Reserve Bank introduced the Official Cash Rate (OCR) to control the economy (a tool many overseas central banks have used for many years). This rate is the basis on which all other banks deal with the Reserve Bank. If a bank had surplus money it could deposit this with the Reserve Bank at a rate .25 % less than the OCR and if a bank found itself short it could borrow from the Reserve Bank at a rate .25 % higher than the OCR. The OCR is also used by the market as a yardstick to set the 90-day bill rate. The interest rate that is charged on money Borrowed/Lent for 90 days, the market sets the 90-day bill rate and the market moves this rate in the direction it anticipates the OCR going. If the OCR is set at 6 % and the 90-day bill rate is 6.05% the market expects the OCR will be increased in the future, if it is 5.9% then the market most probably expects the OCR to be reduced in the future.

The other significant impact on interest rates that the OCR, via the 90-day bill market, has is that the banks source their mortgage funds in this market and look to get a margin of 2 % over their cost of funds and this is the bench mark for floating housing mortgage interest rates.

 The OCR affects the 90 day bill rate which in turn influence what the banks charge for mortgages.

In October 2005 the OCR is set at 6.75 %, the 90-day bill rate is 7.29 % yet the banks floating rates are around 9%. The banks’ will therefore be looking to increase their floating rate at the earliest opportunity to maintain their desired 2 % margin. Competition is holding them back but once one increases its rate the others will generally follow very quickly.

You can watch the 90-day bill rate changes in the paper or on the Internet, to help you anticipate what the banks’ floating rates will likely do.

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