More up their sleeve
The RBNZ has signalled that it could take the OCR lower or even negative if the economy needs even more of a boost. However, it is now looking less likely, given the resilience that has been seen in the economy.
A negative OCR is a mind-bending possibility but for most people on the street it would work in the same way as a normal OCR cut. Retail rates (on loans and deposits) would be unlikely to go negative, so it would mean lower, but not negative, interest rates.
The implications in financial markets would be a bit more complicated though, since wholesale interest rates and some deposit rates for large corporates would go negative. Generally speaking, the economy would be affected in much the same way as with a regular cut in the OCR.
That said, at a certain point, a negative OCR can have diminishing or even counter-productive effects on the economy – potentially more than offsetting other stimulatory effects from the likes of a lower exchange rate.
This is because as well as potentially damaging confidence, a negative OCR can squeeze bank profits and reduce the availability of credit.
A squeeze on bank profits can occur because there are limits to how far deposit rates can fall without severely impacting customer retention – at a certain point people would rather take their money out as cash and store and insure it!
If lending rates are under pressure but banks cannot lower their deposit rates further, this will squeeze net interest margins.
One of the additional benefits of the FLP is that it can potentially offset some of the perverse effects that a negative OCR could have on bank profits and credit supply.
Because of the FLP, banks have an additional source of cheap funding, giving them confidence to lower deposit rates a bit more, reducing some of the margin squeeze.
However, the FLP can only offset so much of this impact, meaning there is still a point when a lower OCR can become problematic.
For this reason, we think there is a limit to how low the RBNZ would be willing to take the OCR, perhaps in to -0.5% or -0.75%.
We also think that because of these (and potential other) negative effects, the hurdle to take the OCR negative is a bit higher than for a regular OCR cut – and if a negative OCR was deployed, a gradual, feel-your-way path lower is probably more likely than a very abrupt shift.
The big reveal
Although the RBNZ has previously signalled that a negative OCR is a very real possibility, it is now looking less likely and may not occur at all.
All forecasters have been surprised by the economy’s resilience to the current downturn, which means urgency for further stimulus has diminished. Partly this is because incomes have been supported by the wage subsidy, but that’s now finished.
The economy faces a test in coming months, especially because tourism arrivals are very seasonal, and it is through the summer months that we will feel the pinch there.
On balance, it looks to us like the economic recovery will stagnate as we head into 2021, and that in time the RBNZ will deem that a little more stimulus is needed.
Our current forecast is that by May next year a little more stimulus will be deemed helpful and the OCR will be lowered to 0.1% (or somewhere very close to 0% but slightly above).
Then by August, we think some continued disappointment in the data flow will mean that the hurdle to a negative OCR will be met, with a further cut in the OCR to -0.25%.
The policy outlook is highly uncertain though and has become more finely balanced, depending on developments.
The case appears to be building to err on the side of not employing a negative OCR, but we will continue to wait and see how developments unfold. We can imagine things playing out in a number of different ways (figure 3).
See our recent ANZ Insight: Weighing it up – Possible OCR paths for more on possible scenarios and our ANZ Data Wrap for key data and milestones affecting the outlook.
We expect that the shine will come off the housing market in coming months, but the outlook is uncertain. A better outlook for the housing market than we expect would reduce the need for the RBNZ to take the OCR lower.