Negative Official Cash Rate

Page updated: 9 March 2021

This page provides a summary of a negative Official Cash Rate and how it might work in practice.

Readiness and preparation for negative interest rates

In early 2020, we wrote to the banking industry outlining our expectation that banks be operationally prepared for negative interest rates by the end of the year. We asked that banks’ systems and processes be ready to operate with negative interest rates on:

  • Reserve Bank settlement balances
  • A range of financial products (e.g. bank bills, bonds, interest rate swaps, and derivatives)
  • All products relating to non-retail customers.

We did not ask banks to prepare to implement negative interest rates on products for retail customers. 

As of February 2021, we are satisfied with banks’ progress on this initiative and are confident that our banking system could operate effectively if the Official Cash Rate were lowered to or below zero.

How a negative Official Cash Rate (OCR) would work

Traditionally, raising or lowering the OCR has been our primary tool for monetary policy. A negative OCR would work to support the economy through the same channels as lowering the OCR to a level above zero. 

Lowering the OCR reduces financial market interest rates, which in turn lowers the exchange rate and supports asset prices and inflation expectations. We expect these channels of monetary policy to be effective when the OCR is zero or negative as when the OCR is positive. 

Lowering the OCR also leads to lower retail interest rates, such as bank deposit rates and mortgage rates. However, bank deposit rates are unlikely to fall below zero. In other countries with negative interest rates, deposit rates for households have generally stayed at or above zero, even as other interest rates have declined. This means that the impact of OCR cuts on retail interest rates might be weaker with a zero or negative OCR than when the OCR is positive. 

What the evidence shows

A negative policy rate, the international equivalent to the OCR, has been implemented in the euro area, Japan, Sweden, Switzerland, and Denmark. 

In these countries, lower policy rates have successfully lowered both short-term and long-term interest rates in financial markets.

The primary purpose for introducing a negative policy rate is different across countries. In general, negative interest rates have been effective in supporting economic activity by keeping downward pressure on interest rates and exchange rates.

Zero interest rate floors on benchmark rates with a negative Official Cash Rate (OCR)

Throughout 2020, there appears to have been an increase in the use of interest rate floors in business lending in New Zealand. Interest rate floors apply a minimum interest rate to an otherwise floating-rate loan.

When businesses borrow from banks at a floating rate, the interest rates they pay are sometimes expressed as a benchmark market rate plus a fixed spread. The floating rate rises if the benchmark rate rises, and falls if the benchmark rate falls. If the loan contract contains a zero-floor on the benchmark rate, the interest rate that the borrower pays the bank cannot fall below the fixed spread, even if the benchmark rate falls below zero. 

The benchmark rates used in this type of loan often move closely with the OCR, meaning that when the OCR is negative, it is likely that the benchmark interest rate will also be below zero. 

In May 2020 we wrote a public letter to the banking sector outlining some of our concerns about the presence of zero interest floors in lending. We highlighted two key risks associated with the floors.

  • Firstly, interest rate floors could reduce the transmission of a negative OCR via the bank lending channel. Loans with zero interest rate floors act like fixed rate loans when the floor is binding, as would likely be the case with a negative OCR.
  • Secondly, interest rate floors in loan contracts could create hedging inefficiencies if borrowers do not have access to products to appropriately hedge their risk. Traditional hedging products may no longer provide an effective hedge.

While banks and their customers are free to jointly determine the terms of their loan contracts, we encourage banks to carefully consider the impact that interest rate floors might have on hedge effectiveness and outcomes for both banks and their customers.

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