Economic weather report: Why the 'new neutral' for the OCR is lower and why it matters

Watch on our video page here. Watch on YouTube here. Bernard Hickey delivers an economic weather report in association with BNZ that looks at the 'new neutral' for the Reserve Bank's Official Cash Rate (OCR) ahead of its March Monetary Policy Statement and OCR announcement this coming Thursday. Economists say the Reserve Bank will not have to lift the OCR as high as in previous recoveries because of new regulations and a change in the funding costs for banks. ASB has forecast the 'new neutral' for the OCR is likely to be around 5%, down around 1.25% to 1.5% from the previous 'neutral'. The OCR has averaged 6% since it was set up in 1999. Bank funding costs are now around 1.5% higher because it's more expensive for them to raise money on international markets and they're having to compete much harder on local term deposit markets. New Reserve Bank liquidity rules are intensifying this search for longer term and more stable funding, but it is helping to increase these funding costs. This all means that longer term interest rates for fixed mortgages and term deposits are likely to be higher than at the equivalent points in previous cycles relative to the OCR. However, the net effect is for similar longer term rates in absolute terms. The one wrinkle is that variable mortgage rates and short term deposit rates are likely to be relatively lower than longer term fixed rate mortgages and deposits than at previous points in the economic cycle. In other words, the yield curve is now sloping upwards rather than downwards. That in turn is likely to give the Reserve Bank more traction whenever it tries to slow and speed up the economy because more borrowers will choose variable rates.