Elizabeth Kerr explains the mysteries of the Official Cash Rate – and why we should care about it

By Elizabeth Kerr

NCIS, The GC , The OC, LAPD, The OCR, CSI and JAG.

Question: Which one of the above is not a TV Show?

“Correct”!  The OCR.

Officially it stands for the ‘Official Cash Rate’.

And while our financial system might seem more CSI than we would like, the topic for this weeks’ column came from a reader who questioned: “What is the OCR, what does it mean and why should I care?”

So, never one to shy away from a challenge this is my attempt to make it seem as simple (think The GC) as possible so everyone can understand.

The money box for our banks

The OCR is the interest rate that the central bank (in our case the Reserve Bank of NZ – RBNZ) charges on money that it gives to NZ commercial banks. In this instance the RBNZ is like a money box for the commercial banks to borrow from.

*this is my example… don’t shoot me for not showing every NZ bank in my diagram

If you want to buy a home or take out a personal loan from your personal bank then the amount of ‘OCR interest’ the bank is paying back to the RBNZ will have an effect on the interest rate that they would make you pay back to them.

If the RBNZ changes the OCR % rate UP then the banks will usually pass that increase onto you by increasing the amount you have to pay them in interest.

The same usually happens when it goes down.

If you haven’t fixed your mortgage, and the OCR rate changes then chances are that you may receive a polite letter indicating your flexible repayments may be increased or decreased depending on what rate the RBNZ has imposed on the banks money.

This is at its most basic level how it might effect you, but the OCR is actually capable of a lot more than this. 

Keep reading….

Inflation

Inflation in this context has nothing to do with cup-sizes or tyre pressures, but instead refers to the buying power that our money has.

For example, let’s say today you can buy a Pizza for $10.00. If inflation is just 1% then next year you can expect to pay $10.10 for the same pizza.

The RBNZ has the important job of keeping inflation in-between 1% – 3% per year; and it can do this by moving the OCR up and down depending on what we as a country need to be doing – spending or saving.

Cheap money is good money right? 

Wrong!

If the OCR is low (today it is just 3.5%), and banks don’t have to pay much to use that money, then they can lend it out to you relatively cheaply.  

When that happens you might feel a little flush and be tempted to pay more for things that you really want, or buy things that you don’t really need. If this goes on for too long, then prices would eventually start getting out of kilter and your favourite Big Mac Combo might set you back $12 instead of $8.90 all because your money is cheaper to come by, and thus its purchasing power diminishes.

Back to the Future

In 2008 when RBNZ had OCR interest rates at 7%, the interest on our mortgages from the bank hovered around 10%, therefore you may have only afforded a $350k house by taking into account the cost or repayments on that loan.  

But now interest rates are 3.5% from the RBNZ and between 5-6% at our banks so you feel more confident about splurging on an extra bathroom and a few extra bedrooms in a better suburb because the cheaper interest rates means you can afford it.

Reading the future

Now what if you got wind that the OCR was going to stay the same, or even get lower for the near future?

Well you’d probably feel more optimistic about putting your extra-best-stretch-price on a tender document for a house you’ve got your eye on, and you might feel quite optimistic about your spending and earning powers.

So if you’ve kept reading this far you can see that the OCR affects the NZ economy by affecting the amount we are happy to pay for something, and in turn keeps inflation under control.

Big Brother is watching….

The RBNZ checks in on us approximately eight times a year to see how we as a country are performing.

No one ever knows for sure if the rates are going to be moved up or down but economists usually have a good crack at guessing what the RBNZ will do a week or so before the announcement.

If this conjures up images of Groundhog Day the movie then you wouldn’t be far wrong because the RBNZ hasn’t changed the OCR rate since July last year. (click here to see all the rate changes since OCR stick was introduced in 1999)

SO, why all the fuss over Auckland House prices and the OCR?  

People are feeling really spendy-bendy for a number of reasons and the cheap cost of borrowing money from the bank only adds fuel to this price rising inferno in Auckland.

If the RBNZ increased the OCR rate to the banks and thus made it more expensive for someone to borrow money for housing, then that might bring down people’s appetite to take on too much debt.  

But what about the rest of the country then, nowhere else are experiencing such dramatic house price rises… so why should we all be slugged with a higher cost of borrowing just to rein in Auckland house prices, you ask?

And therein folks lies a problem with no clear answer….

The OCR and my money machine?

As always, everything comes back to your money machine. What is a money machine again? Repeat after me: “A money machine spits money at you, to fund your lifestyle, without having to go to work” (unless you want to). Imagine the tree that your parents said didn’t exist when you were growing up…..well they kind of lied… it’s not a tree at all, it is a well planned and diversified machine instead.

If you’ve managed to siphon money away to fund your future lifestyle then you want that money to have some kick-arse purchasing power and not be reduced to chump change because of inflation. It would suck to have saved so diligently only to have to part with $5000 just to get your weekly groceries. It’s for this reason that the OCR is such an important tool for the RBNZ so that it can prolong our money’s purchasing power for our lifetime.

SO, I hope dear reader that I’ve gone part way to making the OCR seem a little more relevant to you personally.

(Just a reminder that I’m not a Financial Advisor and anything I write should be taken with a grain of salt … or better still to your nearest AFA if you are contemplating making any financial changes, cheers!)