Diana Clement: How low can interest rates go?

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Opinion

Interest rates are falling at such a rate in New Zealand that they could end up in negative territory. That can be hard to get your head around. But just think of it as another interest rate (OCR) cut, says Westpac's chief economist Dominick Stephens.

There is no guarantee we'll see negative interest rates here, but it is an option the Reserve Bank of New Zealand (RBNZ) has flagged the possibility more than once, says Stephens. It would take time for the banks to get their systems ready for such a momentous move, he adds, which makes it unlikely to happen until early next year.

In theory, negative interest rates would mean banks paying homeowners instead of charging them interest. In practice that's not going to happen, says Stephens.

Even if the Official Cash Rate (OCR), which governs what banks charge on loans and pay savers goes very negative, deposit rates can't go below zero because customers would just take their money out and stuff it under the mattress, says Stephens. "Banks are going to want to maintain a margin between deposit and lending rates, because that's how they earn their living," he says. "So that means there is also a limit to how low mortgage rates can go."

The more the OCR falls, the harder it gets for savers to make any money on term deposits and bonds. Here's the rub. One of the reasons for the RBNZ to drop interest rates is to push us to look at investing in assets that will help the economy recover. That's the maths behind the move, says Stephens. If your money is invested in local shares/growth funds or business we can get New Zealand working again.

If you can stomach the ups and downs of shares or growth funds that invest in shares, you're likely to get a better return. Low interest rates mean businesses can borrow to do bigger things, which in theory improves their outlook and your share price. Stephens is expecting a post Covid-19 recovery and when that happens lower interest rates will result in share prices rising.

Another reason to cut interest rates is that the RBNZ and government want us to splash the cash and spend more, which is what we tend to do when our mortgage costs drop and the return on term deposits are negligible.

Then there's the spectre of deflation. We may almost all hate inflation, but deflation, when prices for goods and services deflate, can be worse for your finances.

Share markets might look scary to investors who aren't accustomed to investing in anything other than KiwiSaver. But this may be the time to find out more, providing the move fits with your investment goals, says Tim Fairbrother, authorised financial adviser at Rival Wealth.

When it comes to KiwiSaver and managed funds, says Fairbrother, don't think that putting your money in a conservative or bond fund is an alternative to term deposits.

Conservative funds often hold around 75 per cent of your money in bonds, says Fairbrother. Some of those bonds are from overseas and a third of global bonds are already paying negative interest rates (coupons).

"If interest rates did become negative, conservative funds could be impacted a lot more than growth funds," says Fairbrother.

Fund managers can do a little juggling to lessen the pain. An example of that juggling, explains Fairbrother, could be buying foreign bonds in the hope that they'll make some money on the exchange rate, or they can gain on the resale price, which can fluctuate.

If your borrowing is mainly on credit cards and personal loans, don't expect your interest to fall hugely even if we get negative interest rates. Lending on credit cards is risky for banks because they can't repossess your house, car or other things if the loan goes bad. If you're paying 19.95 now and the OCR drops by 1 per cent into negative territory, you'll maybe pay 18.95 per cent, if you're lucky.