What really changed in last week's Official Cash Rate review? Mostly it was about getting Kiwis in the right frame of mind to drive an economic recovery

So, what really happened last week is that the Reserve Bank (RBNZ) decided we all needed cheering up.

And that’s not anything like as twee as it sounds. The RBNZ wants Kiwis to get into a better mood - so, they will start spending again. They want the mood of the nation to reflect the reality that interest rates are going down, those with mortgages are getting 'relief' and things can get better. But we need to drop the pessimism and caution.

It’s the only real logic I can draw from yet another leap between ‘hawkish’ and ‘dovish’ statements by our central bank and, yet, the more I think of it, the more I see it as quite a shrewd marketing ploy - if not without risk.

When we look hard at the Official Cash Rate (OCR) decision of August 20, what really changed? Short answer - not very much. It just FELT like a lot changed.

The RBNZ dropped the OCR from 3.25% to 3.00 - but that was widely expected and nobody that I’ve heard has a compelling argument to say that cut should not have happened.

So, what else? Well, in terms of ‘done’ things - actually nothing tangible. And yet, there’s been a huge reaction.

Okay, so intangibles? The key thing was the new OCR projection in the back of the August Monetary Policy Statement. In very simple and literal terms the RBNZ is now suggesting (and remember, it’s never a promise) there may be one and a fifth more cuts to the OCR than it previously indicated. It chopped 30 basis points off its projected ‘terminal’ OCR, taking that down from a finishing point of 2.85% to a new endpoint of 2.55%. And the timing was brought forward.

I had a go at briefly outlining how these projections work in my preview of the August OCR review.

In very basic terms, based on the projection made at the time of the May OCR review, the RBNZ was then seeing a 60% chance the OCR would go to 2.75% by early next year. With the new projection the RBNZ now sees an 80% chance the OCR will go to 2.5% by late THIS year.

What we are saying then is we might see one more cut than we were going to get - and it will be earlier. But as of now, a week on from the OCR review, nothing is different to what we might have anticipated. The OCR is on 3.00% where we expected it to be and any future cuts are very much at the wish and judgement of the RBNZ.

A cunning plan

Move on, nothing to see here? Well, that’s not what the markets thought, is it? Which is why I think it really was quite a cunning bit of marketing by the RBNZ - not necessarily something we would associate with our central bank.

The RBNZ has actually promised us some ice cream tomorrow. That’s what that was all about.

And it clearly decided that was what was needed. And I think it is already working.

There is a recent precedent for this.

If we go back to last year, in May 2024, the RBNZ had its ‘hawkish horror show’ when it completely misread what was happening in the country - and that the economy was falling off a cliff. The RBNZ actually increased the odds that it would raise the OCR again.

Therefore, with no apparent prospect of interest rate relief on the horizon, the good people of New Zealand got into a very bad frame of mind. Nobody spent. The already tanking economy, tanked some more.

At its next review in July 2024 the RBNZ opted to follow the lead of lower-level but more real-time ‘high frequency’ economic data (which was graphically displaying NZ Inc’s journey off the cliff) and did a screeching U-turn, signalling imminent OCR cuts. And the first of these cuts duly came in August 2024 - and oh, was it a relief. And so this relief translated quickly into an upturn of activity. This was sufficient to see GDP turn around from two consecutive quarters of -1.0% in June and September, to a 0.5% rise in the December quarter and a 0.8% rise in March 2025.

The relief-driven rally

My argument would be that this semi-upturn stemmed as much as anything from the sense of relief and came ahead of most Kiwis probably really ‘feeling’ the rate cuts through more money in the bank balances. But as I say, this ‘relief’ came ahead of actual benefit.

RBNZ monthly figures showing the yields the country’s banks make on their mortgage books tell us that the yield on the total NZ mortgage pile continued to go up after the OCR cuts started last year and peaked at 6.39% in October 2024. The descent from there was initially very slow. The yield figure was still at 6% in March of this year, but it’s now starting to move down more meaningfully, falling to 5.66% by June. 

So whatever emotional relief the mortgage holders might have been feeling after August of last year, actual relief has been quite slow. And I really don’t think many of the country’s economists who have talked about a ‘surprisingly’ slow economic recovery, properly built that into their thinking. How quickly we as a country would recover from the effects of the RBNZ-led interest rate hikes starting from 2021 was always a key question. The answer we now know is ‘not as quickly as a lot of us would like’. People expected too much.

In the media conference after last week’s OCR review, RBNZ Assistant Governor Karen Silk said only about half of the 250 basis points worth of cuts made to the OCR at this stage have been transmitted through the economy. So, in other words, we’ve received half, 125bps worth, of interest rate relief so far.

Now, put on top of this the expected 50bps worth of cuts still to come, probably by the end of this year, and we’ve got 175bps of 'relief' still ahead - so, more to come than we’ve actually experienced so far.

Reacting to a 'June swoon'

In terms of the decision to make the big ‘dovish pivot’ at the latest OCR review, the RBNZ seems to have taken its cue from what it did in the middle of last year when it was looking at the ‘high frequency’ data.

And this high frequency data has been strongly suggesting we had another ‘June swoon’ this year.

But how much of that might have stemmed from the US tariff announcements and so was gloomy, nervy sentiment as much as anything? I thought the RBNZ would have been on safer ground to wait till the actual GDP results are released next month before contemplating any big 'dovish' switch.

Based presumably on the high frequency data the RBNZ believes the economy may have shrunk 0.3% in the June quarter.

I’m not sure. The first big doubts for that projection came as soon as Monday of this week, with retail trade volumes expanding 0.5% in the quarter - contrary to virtually all expectations of a decline. As I say, the RBNZ might have been expected to hold fire.

Clearly, however, the RBNZ decided it wanted to put positive sentiment out into the economy - to the point where it was prepared for now put to one side the fact that it is expecting inflation to get to the top of its 1% to 3% range (it was 2.7%, annual rate as at the June quarter).

This, for me, is where it gets interesting.

An early Merry Christmas to the banks

The banks have now got exactly what they would have hoped for. They had run out of runway for further significant mortgage rate cuts. But now with last week’s OCR cut and a further anticipated 50bps worth of cuts imminently, they are in a perfect position to start selectively cutting rates again as we move into the spring housing season in the hope of pushing more mortgage business, as well as winning it off the other guys for existing mortgages. Game on.

Does this mean house price rises on, too?

Well, the last time we saw the NZ housing market rampant, it was during a pandemic. The OCR was 0.25%. Mortgage rates dropped below 3% and got lower. Unemployment surged for a bit but then rapidly become virtually non-existent (low point 3.2%). The loan to value ratio (LVR) limits had been (inexplicably) removed. The investors pounced, the FHBs got FOMOed (translation - the first home buyers got fear of missing out). We got a 40% house price surge on top of prices that were already regarded as expensive.

So, things are a bit different now.

This time around interest rates are nowhere near as low (only fairly recently dropping below 5%, but I can certainly see some rates among the big banks being in the 4.25% to 4.5% by Christmas). Unemployment is 5.2% and expected to go a bit higher yet before the end of the year. The LVRs are in place. They’ve been joined by debt-to-income (DTI) limits. The FHBs have been very active in the market, suggesting that there might not quite be the level of frustrated wannabe owner sentiment seen in the 2020-21 period.

The RBNZ, which less than a year ago had forecast over 7% house price growth this year is now forecasting a 0.3% drop for the calendar year - but does see modest growth again (3.9%) next year. But let’s face it, forecasting house prices in New Zealand…that way madness lies.

In the NZ housing market, anything is possible

The RBNZ will be hoping that the various aforementioned factors will not see the housing market get out of order - and it’s a long way from that at the moment. But look, I wouldn't have believed that in the middle of a pandemic, with the borders closed, with a foreign buyer ban in place, we could among ourselves engineer a 40% rise in an already overvalued market. The RBNZ will do well to remain watchful, that's all I would say.

What about inflation? Well, we are being told (again) that it's transitory. We will have to hope so, because in trying to encourage people to get out and spend the RBNZ is potentially opening the door for inflationary pressures.

At the media conference last week the RBNZ top brass were all adamant that the June quarter just past would prove to be the low point for the economy. That's informative. The fact the RBNZ thinks that way means its not worried whether things are in place for a recovery - it just wants the mood of the nation to be better, and to help make the recovery happen. The two cuts therefore seen as likely before the end of this year are therefore definitely being done for show rather than because they are felt to be completely essential to physically resurrect the economy.

This does mean that the RBNZ is not necessarily completely locked into further OCR cuts (although it would be unlikely if they didn't go ahead with another two).

This comment by RBNZ chief economist Paul Conway, made to Bloomberg News was revealing:

“We are seeing the weakness in the second quarter as a short-run phenomena driven by policy uncertainty that held back investment and created a bit of uncertainty for households. We do think that’s going to dissipate. I don’t think we need to be overtly stimulatory.”

Recent history might not be a good guide

So, in other words, we needn't think the OCR's heading down to 0.25% again any time soon. Indeed some economists are already suggesting the OCR might start going UP again next year. It's worth bearing that in mind. Particularly if that inflation doesn't prove as transitory as hoped - again.

In the early days of the OCR (introduced in 1999) rises and falls were quite a common thing. That changed after the Global Financial crisis and apart from a 'glitch' in 2014 when the RBNZ responded to 'phantom' inflationary pressures by hiking the OCR 100bps, we go used to it being one way (down) traffic. 

The easy thing to believe then would be that once we've got this recent hiking cycle out of the way it will be back to the good old days of non-existent interest rates. Maybe not.

And we might all want to be a bit cautious on that. But cheer up. And spend a bit too.