Crash course: What's the cash rate?

When he had a look at the Reserve Bank of New Zealand's (RBNZ) official cash rate (OCR) decision, Westpac Chief Economist Dominick Stephens had a couple of choice statements. Namely, that because our exchange rate is very strong at the moment, a cut to the OCR in December is looking very likely. Of course, this sort of discourse can just seem like hieroglyphics to the regular New Zealander a lot of the time  - impossible to read. But the cash rate is well worth paying attention to, as it can have a pretty big impact on your home loan. So with this in mind, let's have a look at what the OCR actually does for you.

It affects NZ bank interest rates

Just like almost anyone buying a house, banks borrow money and pay interest on it (just a lot, lot more than any of us do). They settle transactions with each other (like when someone transfers money to another bank) through settlement accounts, which they all have at the Reserve Bank.

The cash rate impacts how much banks are charged on all of this, which in turn guides where they set rates on home loans. If they have to pay more due to a higher cash rate, then home loan rates will likely go up to cover costs and to account for higher risk. It's important to remember that they aren't chained to each other - when the cash rate goes down, your mortgage calculations won't necessarily change.

So what makes the cash rate change?

Don't be fooled: The cash rate isn't randomly chosen by a bunch of people sitting in an ivory tower (even if it might seem like it sometimes!). A cash rate change is often done to stimulate our economy, by making it easier for investment and business growth.

The New Zealand Institute of Economic Research has a Shadow Board that meets every month, where economists predict what the RBNZ will do - and why. At the end of October, Viv Hall from Victoria University of Wellington (and Shadow Board member) said that uncertainty across America and China's economies meant the cash rate should remain stable. Meanwhile, Scott Gardiner from MYOB thought of the business outlook as 'gloom', and that this could force a reduction in the cash rate. It's a complicated mechanic for something that doesn't actually change that often. But with even a brief understanding of the cash rate, you might get a clearer idea on why your home loan interest rates will go up or down.

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