What is the Official Cash Rate (OCR)?

Before start looking at the OCR, it’s useful to understand what the Reserve Bank (RBNZ)  is all about, because these guys set the OCR. They’re New Zealand’s central bank, and they’re in charge of making sure our financial system is running smoothly and efficiently. 

Their number one job is to keep inflation (the rate at which prices increase) between 1-3% over a 12 month period. The Reserve Bank works a bit like a bank for the banks. Retail banks, like ANZ, Kiwibank and Westpac, hold funds with the RBNZ and borrow from them when they need extra cash. 

The OCR is the interest rate at which the Reserve Bank lends to retail banks. That means the OCR influences the cost of borrowing for banks. When it’s higher they have to pay more to borrow money - when it's lower they pay less. 

When the OCR goes up banks will pass those extra costs on to their customers with higher interest rates (and higher term deposit and savings rates). 

That’s why when the OCR changes, interest rates that banks offer usually follow suit (or sometimes they change in anticipation of an OCR adjustment).

Remember that bit earlier when we mentioned it’s the Reserve Bank’s job to keep inflation between 1 and 3%? Well, the OCR is the tool they use to do that. 

When the OCR increases, the cost of borrowing for consumers and businesses does too. As a result everyone’s got less money to spend, so they borrow less and buy less, decreasing demand. When this happens the balance between supply and demand changes and inflation is pushed downward. 

The good thing is the OCR is usually quite effective. It’s a bit like turning a money tap on and off - when the OCR is turned up money flows into the economy and inflation goes up. When the OCR is turned down the opposite happens. 

The OCR is a relatively effective tool for managing inflation, but the problem is changing the OCR has some nasty side effects.

• When the Reserve Bank increases the OCR it can cause job losses, business failures, decreases in property prices and recession. This happened in 2023 and 2024 - a high OCR of 5.5% has partially caused a recession and an increase in unemployment from 3.2% to 4.3%. 

• When the Reserve Bank decreases the OCR it can add fuel to the fire of asset bubbles and increase risky borrowing. This happened in 2021 when super low interest rates drove a 30.5% increase in the national average house price.

• Another problem with the OCR is that it has a delayed effect since most people fix their interest rates and aren’t immediately affected by changes. This means that the Reserve Bank has to do a bit of guesswork and make changes at least 18 months in advance of when they take effect. 

Mortgage holders are most affected by changes in the OCR, particularly those who bought a house in 2021 when prices were at their peak. 

At this time interest rates were at a record low and banks were being very liberal with their lending. Those who didn’t fix for long could have secured a huge mortgage with relatively low repayments. Then when interest rates started to rapidly go up along with the OCR, their repayments would have gone through the roof.

For example, let’s say you had a $500,000 mortgage, with a 30-year term fixed for one year in 2021 back when the average on year rate was around 2.2%. By early 2024 your interest rate could be as high as 7.35% and your monthly repayments would have increased by over $1,500. All of a sudden you have much less disposable income because more of your money is going towards your mortgage. When some variation of this happens to scores of Kiwi homeowners, demand in an economy decreases and inflation cools off.