Interest rates and the OCR

The interest rate you pay on mortgages and loans and earn from savings changes according to economic conditions and also the base interest rate – called the Official Cash Rate (OCR).

The OCR is set eight times a year by the Reserve Bank of New Zealand, which uses it primarily as a means of influencing inflation. The OCR is also used to stimulate or cool the economy. This is called monetary policy.

By lowering the OCR the Reserve Bank encourages banks to lower their interest rates on mortgages and loans. This means borrowing money becomes cheaper for you and for businesses and affects spending and investment. There is also more money in the economy, which can make prices increase.

If the OCR rises, this mechanism is reversed. You are encouraged to save rather than to spend and borrowing money is more expensive. There is less money in the economy so inflation eases.

The main role of the Reserve Bank is to keep prices stable through inflation targeting. The current target is to keep inflation between 1% and 3%.

Each month the Reserve Bank gathers information about the economy and then uses the OCR to try to influence inflation – by raising or lowering the OCR according to its latest information and forecasts of economic conditions.

The OCR affects all of us directly and indirectly. Most directly it affects the amount of interest we pay when we borrow money and the interest we receive when we save money. If the OCR rises it will affect the cost of goods and services we buy because the businesses that produce them have to pay more to borrow money. At the same time a higher interest rate is an incentive for people to save because they earn more on their savings.

The OCR can also affect the exchange rates of our currency. A rise in interest rates may result in an initial rise in the exchange rate, as overseas investors buy New Zealand currency to invest here. Over time though, a rise in interest rates can lower economic growth, making New Zealand less attractive for investment to overseas investors.

Summary

• The Official Cash Rate (OCR) is set by the Reserve Bank and affects interest rates.
• The Reserve Bank uses the OCR to manage inflation.
• The OCR affects how much we save or spend and the cost of goods and services.