Negative interest rates are coming, or so economists would have us believe, but what would they actually mean?

The official cash rate, set by the Reserve Bank as the benchmark against which the commercial banks set their interest rates, is currently a record low 0.25 percent and the central bank has told banks to be ready by the end of the year for the OCR to go negative. Most economists are tipping it to go into negative territory in April 2021. 

In a nutshell, a negative interest rate means you are charged for saving and you get paid to borrow. That may sound nuts, but the goal is to get more money into the economy. 

However, it is the wholesale rate – the rate banks are charged for holding their money with the central bank – that will go into negative territory.

Everyone agrees that retail rates – the rates for the average borrower – are unlikely to dive into the red. They will, however, go lower than they are now.

What will that do?

Housing demand

On the housing front, mortgage brokers say they are already seeing strong demand for home lending. Lower rates coupled with limited supply will only add to the pressure.

The August report from showed that the stock of listed property across New Zealand was at its lowest level in the website’s 13 years of recording data.  

“The repayments on the mortgage are sometimes at the same level as rental payments or lower, so this is attractive to the first home buyer market,” said the Home Loan Shop broker Martin Duncan.

“If the OCR does go into the negative, and if this then drops the current mortgage rates, this will only stimulate demand further,” he added.

While economists initially made dire predictions that house prices would tank due to covid-19, they haven’t.

The Real Estate Institute house price index for NZ, which measures the changing value of property in the market, was up 9.4 percent year-on-year.

How low could mortgage rates go?

The average two year fixed mortgage rate was 3.7 percent in July, according to RBNZ data. If the cash rate were cut by 50 basis points to negative 0.25 percent, that rate could head below 3 percent. The one year rate could go below 2 percent. 

“To the people on the street I would say retail interest rates, the ones we see advertised by banks, would likely fall to new lows if we see a negative OCR. But don’t expect to see a bank pay you to take a mortgage,” said Kiwibank economist Jeremy Couchman. He said Kiwibank disagrees with the whole idea but "the RBNZ are (seemingly) adamant in their resolve." 

Cameron Bagrie, chief economist of Bagrie Economics, says: “The best way for someone to think about negative rates is probably not by focusing on the term negative but simply that rates are incredibly, and some would say ridiculously, low."

Not worried

The central bank isn’t worried about low rates stoking the housing market right now.

“We acknowledge that lower interest rates inflate asset prices, which is a transmission mechanism that monetary policy works through,” RBNZ governor Adrian Orr said in a speech last week.

However, “higher house prices, for example, make people feel wealthier, more inclined to spend, which supports the economy.”

What about business lending?

Unlike the housing sector, business investment remains tentative. Business lending to non-financial businesses was down around 0.5 percent on the month in July. 

“Uncertainty is making people cautious about putting money to work. Businesses are cancelling investment projects preferring to shore up balance sheets,” Bagrie said.

Some companies, however, are less on the fence.

Freightways said it has always “had an open eye.”

“I think we are going to come into a climate where the strong will survive and there will be some opportunities,” chief executive Mark Troughear said.

SkyCity Entertainment chief executive Graeme Stephens voiced caution but wasn’t slamming any doors.

“I don’t think our appetite to invest into our businesses has waned, other than the timing. We will be more circumspect and cautious about timing just so we conserve our balance sheet in case,” he said.

On another front, finance company UDC chief executive Wayne Percival said he was definitely seeing “green shoots” and June and July saw some of the highest months for motor vehicle financing. The trend had continued into August.  

“It’s a great thing we are seeing some expenditure in the market,” he said, referring to commercial lending, although he noted the one area of challenge is tourism.

UDC has approximately 82,000 active borrowers and loans totaling more than $3.3 billion. It was recently sold to Japan’s Shinsei Bank for nearly $800 million. 

Hoarding cash

The main reason retail rates won’t go negative is because further cuts to the cash rate would squeeze bank margins, limiting their ability to pass on cuts to mortgage holders.

“At a negative interest rate, banks will pay the Reserve Bank to hold funds for them. If the corporate bond market or government debt market went negative then in effect wholesale investors would pay to hold their funds in cash,” said Squirrel chief executive John Bolton.

In order to mitigate this, the central bank is proposing direct funding for banks, which would see the central bank funneling money to trading banks at the negative rate, offsetting any squeeze to margins because they won’t need to fund lending from deposits or outside sources.

There’s a lot of talk about the impact a negative cash rate will have on deposit rates but that may actually be the point.

The central bank “doesn’t want companies or individuals hoarding cash. They want it out in the economy,” said Bolton.

“Companies and corporates are hoarding cash rather than investing it because they are generally more nervous about the future and so want to hold cash,” said Bolton. 

Fund managers are also holding more cash for similar reasons, he said.

“With the sharemarket this high, they are tending to think cash will provide a better return if there is a correction. Cash doesn’t have volatility, doesn’t lose its value.”

Bagrie agrees.

“People look to be hoarding cash. Transaction and savings balances are up across the board.  Households, businesses, local govt etc. The interest rate is basically zero so it's not an investment decision. It’s about having liquidity,” he said.

RBNZ data shows deposits are up $29 billion on the year in July at $390.9 billion and they are up across both the business and households sector.

However, it’s very hard to hold cash at very low – or negative interest rates.