Opinion: A new, lower benchmark for the OCR

By Roger J Kerr For many years the RBNZ has regarded 90-day interest rates between 6.00% and 6.50% as "neutral" for monetary policy settings. Interest rates 2.00% below there were seen as a "loose" monetary stance and 2.00% above as "tight". The global credit crunch, banking crisis and resultant GFC in 2007 to 2009 has changed that paradigm permanently in my view. It may be a little premature to make this call, however the evidence is gathering that the new "neutral" for monetary policy setting in New Zealand is 90-day interest rates at 5.00%. I do not see wholesale 90-day rates moving much above 5.00% over the next two years, unless the economy takes off to 5% GDP growth rates and inflation risks go up with the booming economy. It is very hard to see this scenario happening in the current environment. The three major factors that support this paradigm shift are as follows:- "¢ Bank lending margins to wholesale and retail borrowers have increased by 1.00% to 2.00% over the levels being paid in the 2002 to 2007 period. If the RBNZ want to slow down the economy to contain inflation risks by increasing interest rates, the base-interest rate they need to set before margins can consequently be 1.00% to 2.00% lower. "¢ The "Core Funding Ratio" by which the RBNZ can now control bank funding and thus lending growth is another lever the RBNZ can pull in the control of inflation. In the past they have only had the interest rate tool, and relied too heavily on it with damaging economic consequences. The funding ratio regulations take the pressure off interest rates. "¢ The RBNZ are now very well aware that their shoving interest rates up and down over the last ten years caused massive NZ dollar currency volatility and did not really impact on the sources of inflation. The collateral damage to the economy from these policies is now better understood, with many manufacturing exporters leaving town and those remaining not investing/expanding. A future interest rate curve between 5% and 6% will mean that NZ interest rates will be very similar to other economies and we will no longer stand out as a high yielding currency to buy up. Reduced currency stability will result in more investment in the wealth-producing export sectors and much improved overall-economic performance. John Key and Bill English should be giving this message very clearly to Alan Bollard, if they have not already done so. Both borrowers and investors need to think hard about this potential and major shift in the interest rate risk profiling decisions they make over coming months. "”"”"”"”"”- * Roger J Kerr runs Asia Pacific Risk Management. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com