KEY POINTS:
Reserve Bank Governor Alan Bollard reviews the official cash rate monthly. Here's our bluffer's guide to the OCR.
Facts:
* The official cash rate (OCR) is the interest rate set by the government-owned Reserve Bank of New Zealand.
* It is the interest rate that the
Reserve Bank, sometimes known as the banks' bank, applies to the settlement accounts that all trading banks - the ones that we have our savings and mortgages with - are required to have with the Reserve Bank.
* The OCR was introduced in March 1999 as a mechanism to help the Reserve Bank control inflation.
* By adjusting the OCR, the Reserve Bank can influence the cost of borrowing money and in turn, the level of economic activity and inflation.
* When interest rates are high people are less inclined to borrow and spend their money, instead saving it to take advantage of the high interest rates.
* The OCR is reviewed by the Reserve Bank eight times a year.
What is a settlement account?
Most New Zealanders have a bank account to handle their deposits and bill payments. The Reserve Bank settlement accounts operate in a similar manner.
Settlement accounts are used to transfer money between different banks, for example, if you are paying your electricity bill and your electricity supplier has an account with a different bank.
Your bank will pay the electricity company's bank on your behalf using cash in their Reserve Bank settlement account.
Ok, but where does the OCR come into all this?
The official cash rate is the interest rate that applies to any surplus cash or debts the banks have in their settlement accounts after they've processed the day's transactions.
For banks with money in their settlement accounts, the Reserve Bank pays them interest at a rate 0.25 per cent below the OCR. Currently this would be 7 per cent.
For the banks that are short of cash, the Reserve Bank offers to lend to them cash overnight at an interest rate 0.25 per cent higher than the OCR or 7.50 per cent at the current rate.
How does it affect my mortgage interest rate?
Changes in the OCR have a flow-on effect to other interest rates, including the floating rates banks charge for house mortgages.
However, only 15.5 per cent of money lent for mortgages is on a floating rate with people opting to borrow most of their money at a fixed rate for a period of up to five years.
This means changes in the OCR will only affect borrowers as they re-fix their mortgage for another term.
Who are these Japanese housewives and Belgian dentists I keep hearing about?
Strong consumer spending has meant Reserve Bank Governor Alan Bollard has needed to keep the OCR higher than equivalent interest rates around the world.
As a result, international investors - commonly said to be Japanese housewives and Belgian dentists - buy New Zealand dollars because they can earn much higher interest on kiwi dollar assets than they would on their local interest-bearing investments.
The demand for the New Zealand dollars pushes the rate up in comparison to other currencies - good news for people importing goods who don't have to pay as much for overseas products but bad news for exporters.
So what is Allan Bollard likely to do to the OCR on Thursday?
Ten of 15 forecasters polled by Reuters last Friday expect there to be no change to the official cash rate.
