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What is the Official Cash Rate and how does it affect you

The Reserve Bank of New Zealand will be announcing the new Official Cash Rate (OCR) this coming Thursday September 11th. The Reserve Bank is charged with maintaining price stability and making sure inflation doesn't rise to a level that would cause goods and services to become unaffordable. The inflation target is agreed by the Reserve Bank and the Minister of Finance. The current target is between 1 and 3 percent on average over the medium term, with a focus on keeping future average inflation near the 2 percent target midpoint.

The OCR is the interest rate set by the Reserve Bank, which they charge to other banks. “Most registered banks hold settlement accounts at the Reserve Bank, which are used to settle obligations with each other at the end of the day. For example, if you write out a cheque or make an EFTPOS payment, the money is paid by your bank to the bank of the recipient. Many hundreds of thousands of such transactions are made every day. The Bank pays interest on settlement account balances, and charges interest on overnight borrowing, at rates related to the OCR”, as explained on the Reserve Bank’s website.

But what’s important is how it affects you. The Reserve Bank uses the Official Cash Rate (OCR) to influence the rates people in New Zealand face. When they change to OCR, they are changing the rate they charge when lending money to other NZ banks. The banks then modify the interest rates they charge or pay to their customers according to the OCR. Although there are other factors that influence the NZ banks interest rates, the OCR is probably the most important factor. This is why a change in the OCR affects both borrowers and savers.

When the OCR is low, it favours borrowers, because they are expected to pay less money towards their debts. It also causes people and businesses to increase their spending as there is less of an incentive to save, encouraging economic growth.

If the OCR is high, savers benefit from higher returns on their money, encouraging people to save and spend less. This can cause economic growth to slow down, and it is used by the Reserve Bank to ensure the economy doesn't overheat causing high inflation rates.

The OCR was introduced in 1999 and it is reviewed eight times per year by the Reserve Bank.
Image courtesy of pakorn / FreeDigitalPhotos.net