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Interest rates play a significant role in shaping New Zealand’s property market. With the Reserve Bank of New Zealand (RBNZ) at the helm of monetary policy, the official interest rate, known as the Official Cash Rate (OCR), is one of the key tools used to influence the economy. Alongside the OCR, banks’ own lending rates are crucial in determining the borrowing costs for homebuyers and investors, and thus the overall state of the property market.

Official Cash Rate (OCR) and its Influence

The OCR is set by the Reserve Bank of New Zealand (RBNZ) and is reviewed seven times each year and is keenly watched by economists, investors, and the property market. The OCR directly influences floating interest rates that banks offer to borrowers, but it is only one piece of the puzzle.

The RBNZ uses the OCR primarily as a tool to control inflation, with a target range of 1-3%. By adjusting the OCR, the central bank can influence the cost of borrowing. When the OCR rises, borrowing becomes more expensive, and when it falls, borrowing costs decrease. However, the OCR is not the only factor determining interest rates in New Zealand’s lending market.

Banks and Interest Rate Determination

While the OCR plays a vital role in setting the general direction of interest rates, individual banks determine their own rates based on several factors. The most significant pricing elements include the cost of funds (which refers to how much it costs for banks to acquire the capital they lend out) and the banks’ profit margins.

Banks may also adjust their rates to meet market conditions and compete for customers. For example, they may offer promotions or temporary reductions in interest rates to attract new customers or gain market share. Alternatively, if market share is not a priority, a bank may decide not to lower its rates even if competitors are offering lower deals. Over time, however, this can lead to a loss of customers, prompting the bank to adjust its rates to stay competitive.

Some banks also adjust their rates in anticipation of future RBNZ OCR decisions. If a bank predicts an OCR increase, it may raise its rates in advance to protect its margins. Similarly, a bank may lower its rates ahead of a predicted OCR cut to maintain or boost its customer base.

The Link Between OCR and Inflation

The OCR is fundamentally tied to inflation trends in New Zealand. The RBNZ’s primary objective is to keep inflation within a target band of 1-3%. Inflation affects the cost of goods and services, and the central bank uses the OCR to either stimulate or cool down the economy.

For example, if inflation starts to rise significantly, the RBNZ may increase the OCR in an attempt to cool spending and bring inflation back into the target range. Conversely, if inflation is low or there is a risk of economic downturn, the RBNZ may lower the OCR to stimulate borrowing and spending.

Inflation forecasting can provide valuable insights for predicting future OCR moves. In 2021, for instance, the Consumer Price Index (CPI) showed signs of inflationary pressure, largely driven by COVID-related supply chain disruptions. This prompted an increase in home loan rates as banks and the RBNZ responded to rising inflation expectations. By monitoring such indicators, homeowners and investors could have locked in historically low fixed mortgage rates like 2.99% for 5 years and avoided the much higher rates that came after.

The Impact of Interest Rates on House Prices

Interest rates have a direct and significant impact on the property market, particularly house prices. The relationship between rates and house prices is simple: when interest rates rise, house prices tend to fall, and when interest rates decrease, house prices often rise.

When the RBNZ raises the OCR, it leads to higher floating mortgage rates. This, in turn, raises the banks’ test rates (the interest rate they use to assess a borrower’s ability to repay a loan), which reduces borrowing power. When borrowing power is limited, potential homebuyers can afford to borrow less, leading to a decrease in demand for housing and a potential drop in house prices.

On the flip side, when the RBNZ lowers the OCR, interest rates tend to fall, making borrowing cheaper. This increases borrowing power, as buyers can afford to take on larger loans. Higher borrowing power supports increased demand for housing, which can drive up property prices.

This dynamic was evident in the post-2008 global financial crisis period and again during the COVID-19 pandemic, when the RBNZ lowered the OCR to stimulate economic activity. In both cases, lower interest rates helped fuel a property market boom, as increased affordability and low borrowing costs encouraged more people to purchase homes.

Final Thoughts

Interest rates, as set by the RBNZ through the OCR, are a key determinant of New Zealand’s economic and property market landscape. While the OCR directly impacts the cost of borrowing, banks also play a role in determining the rates they offer, adjusting them based on market conditions, competition, and their own predictions of the OCR path.

For property buyers and investors, understanding the connection between interest rates and house prices is crucial. When rates increase, borrowing power decreases, which can lead to lower house prices. Conversely, when rates decrease, borrowing power increases, supporting higher house prices.

As we move into 2025, keen observation of the RBNZ’s monetary policy decisions and economic indicators like inflation will be important for those looking to navigate New Zealand’s property market. The next OCR announcement, published here, will likely set the tone for interest rates and the property market for the months ahead.

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