If you’ve been living in New Zealand for the past couple of years, you’ll know we’ve been at war with the inflation beast. This has affected the cost of doing business and the cost of living. Ultimately, the effect of high inflation is businesses paying more for the inputs they need and individuals paying more for the goods and services they consume. We’ve all experienced this inflationary result – our money loses purchasing power.
CONTROLLING INFLATION
In a bid to influence economies and particularly to control inflation, central bankers around the world wield a tool known as the Official Cash Rate (OCR). Our Reserve Bank of New Zealand (RBNZ) is no exception to this.
The Reserve Bank meets approximately every six (6) weeks to review and, if it thinks appropriate, adjust the OCR. When considering what changes (if any) are needed to the OCR to stimulate or dampen economic activity, the Reserve Bank will review factors such as domestic and global economic conditions, inflation forecasts, employment levels and the general health of the financial system.
OCR’S EFFECTS
Focusing purely on the borrowing side of the ledger, the OCR affects the rate of interest New Zealand commercial banks borrow money at from the Reserve Bank. This in turn affects the short-term interest rates banks charge their customers on the loans they make. Hence, there is an interplay between the OCR and domestic short- term borrowing rates. Banks are in the business of making money. Consequently, if banks must pay more for the money they borrow, they will pass on this cost to us. This results in our borrowing costs increasing with consequential higher loan repayments.
A WALK DOWN MEMORY LANE
A quick look back shows the OCR sat at 1% back in 2019. In March 2020 when the worldwide pandemic COVID visited our shores, the RBNZ reacted and reduced the internal rate to a mere 0.25%. It took this step thinking a low OCR would better provide for credit and market functions, assisting the economy to cope with the effects COVID was expected to bring.
A low internal borrowing rate meant domestic banks could reduce their borrowing rates. This they did, making it easier and cheaper to obtain credit. Companies and people unsurprisingly borrowed. Cash flows improved. New Zealanders bought and consumed increasing amounts of goods and services. Some businesses invested in projects and technology and grew their head count. The party was in full swing for the next 18 months.
Come late 2021, the RBNZ was of the view economic recovery had begun. Thus, it thought it appropriate to reduce monetary stimulus. Accordingly, the RBNZ made the first change to increase the OCR on 6 October 2021. This would be followed by another 11 increases, with the OCR coming to rest at a height of 5.5% in July 2024. During this time, predictably borrowing interest rates increased, business investment was curtailed, house prices fell, our export sector saw a reduction in goods shipped offshore and inflation climbed. We all started to feel some pain.
Naturally, businesses cut their cloth where they could, as did households, which eventually saw inflation decreasing. Reacting to the weaker economic conditions, the RBNZ made the first reduction to the OCR on 9 October 2024, taking the rate from 5.5% to 4.75%. We saw further reductions to the rate in November 2024 and again in February 2025, where it currently sits at the time of writing at 3.75%. In summary, we’ve experienced a full cycle of dialing down the OCR, then up and then down again.
HOW LOW WILL INTEREST RATES GO?
The big question now is where will the OCR come to rest? This is an important question because unlike long-term interest rates, which are influenced by the bond market, short-term rates are influenced by the OCR. When the wholesale price of money is affected, short-term interest and savings rates tend to be affected as well. Thus, what we pay and what we earn in interest influences our borrowing, saving and spending decisions, consequently determining demand and ultimately, the inflation rate.
Trying to guess where the OCR will eventually sit is like trying to guess how many grains of sand there are on a beach. The Reserve Bank has publicly said however, it wants to get us back to a neutral OCR – one that doesn’t stimulate nor restrict our economy. It sees this sitting around the 2.75% mark. How quickly the OCR reaches this point is a big unknown but on the basis we do get there, short-term retail interest rates could settle somewhere between 4.5% and 5%.
STRATEGIES TO COPE WITH FUTURE OCR’s
Irrespective of where and when the OCR comes to rest, it pays to keep in mind banks won’t necessarily pass on the full OCR reduction they enjoy to their borrowers. Their business is after all to make money for their shareholders. Given this, it is far better to implement strategies to navigate OCR effects than try to guess where it is going to sit at any given time. Navigation strategies that come to mind include:
We have a couple of other handy tips to pass on to you to help you succeed this year, which you’ll find in our Boosting Business Success 2025 article so keep reading.
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