There’s something mildly exciting about the Reserve Bank doing something unexpected. It’s like finding $5 in your jeans. I’m a borrower so I’m loving the prospect of lower rates but I’m also a realist and know that the reasons behind the OCR dropping are worrying. We should all be using this opportunity to pay back debt and build safety buffers into our lending.
Wholesale markets were already pricing with a 100 percent certainty a 0.25% now and another one at the next OCR meet-up. That’s why you won’t see too much of a reaction from the banks in the short-term. Expect to see a 0.05% to 0.10% (5-10 basis point) reduction from the major banks.
It’s getting harder for banks to make more money. Bank revenue is called net interest income and is the difference between lending rates and deposit rates.
The challenge for our banks is that a sizeable chunk of deposits are already earning less than 0.25%, meaning they cannot drop these rates anymore. Wholesale rates and term deposit rates can still fall (and will) but this inability to keep dropping deposit rates makes the OCR increasingly ineffective.
This is more so in New Zealand because the Reserve Bank uses another tool to control banks called the Core Funding Ratio. This ratio dictates that New Zealand banks have to raise local deposits and cannot rely on cheap overseas money. In other words, banks need to keep competing for deposits.
The other factor that is also looking more certain (and I think is a good thing) is increasing the amount of capital banks need to hold. This comes at a cost and that cost will ultimately be borne by borrowers further disconnecting borrowing rates from the OCR as it heads towards zero.
The OCR in Australia is also 1% and over there, fixed home loan rates are sneaking below 3.00%. As a borrower the thought of a rate below 3.00% is titillating. However, Australia doesn’t have the same funding issue as our New Zealand banks. They are awash with Superannuation funds and savings, and term deposit rates are paying a measly 1.70% compared to 3.00% here.
If we are going to see materially lower mortgage rates that will only come about if banks can drop term deposit rates. It’s going to get harder and harder for retirees to earn an income on low risk deposits so at an economic level lowering interest rates is not a free ride. Someone always has to pay.