Last week’s Monetary Policy Statement firmed up the sense that rate hikes are on the way from mid-year. But the market’s attention was instead captured by the RBNZ’s comments on the new interest rate environment.
Since the global financial crisis began, the cost of borrowing for banks and corporates has risen substantially. The RBNZ estimate that the marginal cost of bank funding is currently around 150 basis points above the OCR, compared to 20-30 points pre-crisis. This additional ‘wedge’ means that, for any desired level of market interest rates, the OCR will be lower than it would otherwise have been.
This in itself is not a new development, In fact, the RBNZ have been setting policy on the basis of a shock to funding costs for some time – after the first OCR cut in July 2008 they noted that “the cost of funds raised abroad by banks has been rising in recent months as the international financial situation has deteriorated.
Today’s cut will help to mitigate the effect of these increases on the actual borrowing costs paid by firms and households.”
The crucial difference in last week’s statement is that the RBNZ have made explicit their judgement about funding costs in the future. They have assumed that the ‘wedge’ will remain constant at around 150bps over their forecast horizon – not a permanent change, but close enough for policy-making purposes.
