When you start out on your journey to homeownership, you’ll very quickly realise there’s a whole language of jargon and acronyms for you to wrap your head around.
Among the long list of terms you’ll need to get to know as a new (or aspiring) homeowner, one of the most important is a little something called the OCR, or the Official Cash Rate.
If the term “OCR” is ringing some bells, that’s probably because it’s in the news a fair bit. Usually, you’ll hear it around the time of an OCR announcement, which happen seven times a year, where the RBNZ basically tells us whether our interest rates are going up, down, or staying put.
Because it’s so closely tied to interest rates, what’s happening with the OCR has *massive* consequences for Kiwi borrowers and their wallets.
To explain how the OCR works, we first need a bit of background on the role the Reserve Bank (RBNZ) plays in our economy
As our Central Bank, the RBNZ’s main job is to keep our financial system safe, stable and running efficiently.
It has a whole lot of different responsibilities under that remit, but in the context of the Official Cash Rate, these are the two key things to know:
These days, the RBNZ’s goal is to keep inflation somewhere between 1% and 3% over any given 12-month period, but that’s no easy task
Inflation is driven by a whole range of factors, like demand for goods and services being higher (sometimes much higher) than the available supply, as well as input factors like wages, transport costs and raw materials.
A degree of inflation is completely normal — and so you’d usually expect prices to track steadily upwards over time.
Sometimes, though, there can be a whole bunch of factors that throw the supply and demand equation completely out of whack.
The global pandemic was a prime example, when interest rates plummeted and house prices soared, border closures caused conundrums in the labour market, and the supply chain went down the toilet. Then there was geopolitical events like the outbreak of the war in Ukraine, causing oil prices to go up, and before you knew it, inflation had skyrocketed.
And it's the Reserve Bank's job to get that back under control.
Well, remember how we said that the RBNZ is the banks’ bank?
The OCR is the interest rate the banks earn on any money they’re holding with the RBNZ — and it’s also the interest rate they pay if they need to borrow funds.
That means, when the OCR goes up (or down) it directly impacts banks’ interest costs, making it more (or less) expensive for them to borrow money.
And, just like lots of other businesses, the banks pass those changes down the line to their own customers in the form of higher lending rates — and, equally, higher deposit rates.
So that’s why when the OCR moves mortgage rates (usually) follow.
It’s worth noting that the most important thing when it comes to fixed home loan rates is what the markets anticipate will happen with the OCR — so, sometimes you’ll see fixed home loan rates move even when the OCR hasn’t.
Floating rate mortgages, meanwhile, are pretty tightly linked to changes in the OCR.
How that works is because, when interest rates are low (like they were at the height of the pandemic), that makes it really cheap for people to borrow money to buy things. That, in turn, drives demand in the economy.
In that scenario, inflation is what happens when the supply side of the equation doesn’t, or can’t, grow to match demand.
When it hikes up the OCR, the Reserve Bank knows those increases will be passed on to customers in the form of higher interest rates. And higher interest rates mean:
Both of those factors help to take heat out of the economy because people have less to spend elsewhere. Demand then falls back more closely in line with the supply side of the equation, and that helps to bring inflation back down again.
The nature of interest rates, especially as far as mortgages are concerned, means that it takes a while for changes to the OCR to trickle through to the economy.
In a high-OCR environment, it’s only as mortgage borrowers come to the end of their existing fixed rate term (and have to roll over to current rates) that they start to feel the pinch.
Borrowers who lock in long-term at the bottom of an interest rate cycle, will be unaffected by rate increases for years. While those who lock in for a year or two will start to feel the impact of interest rate hikes much sooner.
This delayed flow-on effect means it’s a pretty tough balancing act for the Reserve Bank to get right. It often faces criticism for waiting too long to hike rates when inflation rears its ugly head, and too long to drop rates again once inflation is back under control.
Safe to say, we don’t envy the Reserve Bank the job of having to strike that balance.
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