Economists lay out 'worst-case scenario' for interest rates

Friday, 4 October 2019

New Zealand's Reserve Bank could cut the official cash rate (OCR) as low as -0.75 per cent in a worst-case scenario, but borrowers shouldn't expect that to mean they would be paid to hold their mortgages.

ASB economists say they expect the cash rate to be cut to a low of 0.5 per cent this cycle.

But 'if the proverbial does hit the fan' there were other courses of action the Reserve Bank could take, including cutting the official cash rate to its minimum, which the bank economists said was about -0.75 per cent.

Negative cash rates have been used overseas, including by the European Central Bank, Bank of Japan and Swiss National Bank.

* Warning for borrowers: Careful what you wish for on interest rates

* Westpac says OCR could fall below 1 per cent this year, as export prices slide**

One Danish bank launched a negative home loan rate in August, paying borrowers 0.5 per cent a year to take out a loan.

But economists said even a negative official cash rate would not mean New Zealand borrowers received that benefit.

ASB economist Mark Smith said rates could only drop to the level at which banks could still attract sufficient deposits, which he said would need to be a mildly positive rate.

An official cash rate of -0.75 per cent would be the lowest it could go and still generate those slightly positive retail deposit rates, he said.

It is a rate that the Reserve Bank has already indicated it sees as a lower limit.

But Smith said mortgage rates would need to be higher still, probably in the 3 per cent range.

ASB economists say they expect the cash rate to be cut to a low of 0.5 per cent this cycle but it could drop much lower.

Gareth Kiernan, chief forecaster at Infometrics, said a -0.75 per cent cash rate seemed unlikely.

But he said the Reserve Bank had indicated a strong desire to cut interest rates in a 'pre-emptive' fashion.

'With recent domestic economic data continuing to deteriorate and global economic concerns showing no signs of abating, further aggressive action in November and February can't be ruled out. Although two more 50-point cuts would only get the OCR to zero, there's not a lot of brightness on the economic horizon to suggest further cuts wouldn't happen. It's an extreme scenario, but the bank has certainly surprised with its monetary policy decisions since March,' he said.

He said a more important question for borrowers was what happened to longer-term wholesale rates.

'So far since just before the bank signalled a rate cut was coming in late March, bond rates across the curve have dropped by a similar amount to the OCR.

'If markets expected the Reserve Bank's actions to be effective in stimulating the economy, I wouldn't expect bond rates to drop by as much as the OCR, because cuts to the OCR would eventually generate inflation and necessitate a higher OCR at some point in the future.

'At this stage, though, markets don't seem to have a lot of faith in the Reserve Bank's ability to kickstart the economy, resulting in the dip in bond rates and, therefore, fixed mortgage rates that we have seen.'

He said most forecasters expected bond rates to lift.

But they had been predicting that for three years and it still had not happened, he said.

'If anything, rising long-term rates seems less plausible now than at any stage since 2016. Arguably, the forecasts might be suffering from an element of mean reversion whereby rates are expected to return to 'normal'. That being the case, if the Reserve Bank was to continue acting aggressively, fixed mortgage rates under 2.5 per cent could be on the cards.'