You may have heard some discussions earlier this year about the possibility of New Zealand’s OCR (Official Cash Rate) to drop below zero. Currently, the OCR set by our Reserve Bank is very low at 0.25 and it has been decreasing since 2015. Negative interest rates is an unusual scenario, but it is likely to occur during a deep economic recession such as the one we’re experiencing today, caused by COVID-19.
How the OCR affect interest rates
The OCR is effectively the interest rate set by our Reserve Bank at which it lends money to retail banks. The OCR set by the Reserve Bank affects the interest rates that retail banks offer to their customers. By affecting the interest rates, the Reserve Bank is able to influence the level of economic activity and keep inflation under control.
If the OCR is set to -0.5%, this would be the rate at which retail banks will pay, not the retail rates offered to customers. In this case, retail banks would be charged for holding their money with the Reserve Bank rather than lending it out. It is intended to encourage retail banks to lend more money, at a lower interest rate to customers.
What does this mean for us?
Reducing the interest rate would encourage people to borrow more. When the interest rates are higher, we are more incentivised to save our money and spend less on goods and services. This would also mean that people with mortgages and other loans may experience higher interest payments.
In theory, a negative interest rate means that banks would charge you interest to keep your money with them rather than paying you interest. But a negative OCR does not necessarily mean a negative interest rate for you as “no household or business actually pays the official cash rate” Dominick Stephens, a chief economist said. When the OCR is reduced, retail interest rates would drop, but mortgage and deposit rates are not expected to go into the negative territory.
How it affects your investments in KiwiSaver
Many KiwiSaver providers hold cash and bonds in their investments across different funds. Some KiwiSaver funds have more cash investments than others, while some funds invest more in growth assets, and the same economic event could affect these funds differently.
The reduced interest rate would cause returns on cash investments in your KiwiSaver fund to fall. In the short term though, reduced interest rates will increase the value of investments in bonds as it would still pay investors a higher interest. But if the interest rates stay low, then the returns on newly issued bonds would also be low.
Since investments in bonds and term deposits won’t be as attractive in an economy with a declining interest rate, more people could rush to invest higher in shares which could cause the prices in the share market to rise. This would be beneficial for KiwiSaver funds that hold more growth assets in shares as they would have higher returns. But this also means that there could be a higher volatility due to the uncertainty in the economy.
Another important factor contributing to the increasing prices in the share market would be the decreasing cost of borrowing for companies. Most companies in the share market have debt and when the interest rate falls, these companies could be paying less interest on their debts. When they pay less interest, their profit may increase which in return, could increase their share prices.
What we can do
Negative interest rates may play a big part in how and where future returns are generated by KiwiSaver funds. The market going forward could be very different, so just looking at past returns is not enough. You need to dig in to find what kind of assets your KiwiSaver fund is invested in, and what their investment strategy for the future is.
Our investment team looks into every fund we recommend beyond just past returns and fees and ensures that the fund manager's investment policies are taking into consideration different market scenarios such as negative interest rates. We do the deep digging on your behalf.
We start off with a financial plan and a KiwiSaver strategy first though. Being prepared by having a clear long-term financial strategy is becoming increasingly important. At National Capital, our financial advisors will help you develop a KiwiSaver plan based on your personal circumstances. First submit our KiwiSaver HealthCheck to find the most suitable KiwiSaver fund for you.