50 basis points cut by RBNZ – are they going negative?

The 50 basis points of the OCR (Official Cash Rate) by the RBNZ took everyone by surprise. Cuts of this magnitude generally only occur when significant events happen – 9/11, the GFC, the Christchurch earthquake etc. However the US China trade dispute have significant implications for global trade and ultimately the NZ economy. The idea behind such a cut is to be proactive and get ahead of the curve – why wait and be reactionary.

The Bank has forecast the OCR to trough at 0.9 percent, indicating a possible further interest rate cut in the near future. The RBNZ believe that lower interest rates will drive economic growth by encouraging more investment but you would have thought that such low rates wold have been stimulatory by now. I don’t recall the corporate sector complaining too much about interest rates and according to the NZIER (New Zealand Institute of Economic Research) latest survey of business opinion only 4% of firms cited finance as the factor most limiting their ability to increase turnover. The problem seems to be an increase in input costs for firms which is hard to pass on to consumers.

Lower interest rates have a downside in the reduction in spending by savers and this could also impact on consumer confidence. Any hint of further easing seems to encourage financial risk-taking more than real investment. Central bankers have thus become prisoners of the atmosphere they helped to create. There is still a belief amongst politicians that central bankers have the power by to solve these issues in an economy and politicians keep asking why those powers aren’t being used.

Are negative Interest rates an option?

The idea behind this is that if trading banks are charged interest for holding money at the central bank they are more likely to make additional loans to people. Although this sounds good negative interest rates on those that hold deposits at the bank could lead to customers storing their money elsewhere.

The European Central Bank sees that negative interest rates have an expansionary effect which outweighs the contractionary effect. An example of this is Jyske Bank, Denmark’s third-largest bank, offered a 10-year fixed-rate mortgage with an interest rate of -0.5%. for a ten-year mortgage – in other words the bank pay you to take out a mortgage.

However negative interest rates is seen as a short-run fix for the economy. Getting people to pay interest for deposit holdings may mean that banks have less deposits to lend out in the long-run and this may choke off lending and ultimately growth in the EU.

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