The Official Cash Rate Explained
Rate decisions: who makes them, how and why?
The Reserve Bank of NZ (RBNZ) is our central bank. It makes the call on whether interest rates move up or down. These movements greatly influence our economy and control inflation, which is very important. Let’s take a look.
What’s a central bank?
A central bank protects a country’s economy like a dragon guarding treasure. It’s a country's primary monetary authority. Ours is the Reserve Bank of New Zealand, or RBNZ. Other examples are the Bank of England and the USA’s Federal Reserve. Like in most rich countries, ours is independent of politics. No-one, including the PM, can order it to do things— like lower rates during an election campaign—for short term political gain. Central banks look long term; issuing currency, holding banks' compulsory deposits and, setting interest rates.
Who are these people?
The RBNZ’s existing job description calls for it to keep prices stable i.e. inflation on a tight leash. In addition, there’s a newly created Monetary Policy Committee (MPC) with people from inside and outside the bank that meet seven times a year. This collection of brainy types from business and academia thoughtfully sip tea, and decide whether to cut, raise, or leave interest alone. To do this they scrutinise the latest inflation figures, economic growth, employment, home loans, building activity and consumer spending. They also survey other economies to see how we might be affected by what’s going on overseas. All this is set out in the “remit” and in accordance with the Charter and Code of Conduct.
Controlling inflation and the role it plays
As you’ve read, the RBNZ is our central bank and it – not the government – sets interest rates. Its aim is “to promote the prosperity and well-being of New Zealanders, and contribute to a sustainable and productive economy”. And to keep prices stable and employment strong. These last two objectives are called the ‘dual mandate’.
There’s a few different kinds of interest rates, but the RBNZ controls the cash-rate. It determines mortgage, loan and deposit rates and controls economic activity. The MPC folk must keep inflation between 1-3%— ideally around 2.5%. Inflation is the constant rise in the level of prices where a unit of currency buys less than it did at an earlier time. If it looks like going higher, they raise rates to slow the economy—less people want to borrow money, economic activity slows, prices follow, and, voilà, inflation sleeps. To wake inflation up they can drop rates to stimulate demand and investment.
On decision day, the RBNZ announces its actions at 2pm. There’s usually same day publication of its reasons, any serious differences of opinion about the decision and an overview of our economy. I wouldn’t miss it.
Rates right now
While it does feels like ‘Groundhog Day’ — the cash rates been 1.75% since November 2016 — there is a growing chorus of economists who reckon the next move is down. Watch this space.
Don’t hesitate to reach out to learn more. I’ll work with you to help with finance for a home, a car or whatever else you dream of and help make a plan if rates were to move.