Cutting the official rate to negative would not be effective and could damage confidence and the ability for banks to lend, the boss of a major bank has warned.
The Reserve Bank of New Zealand has asked all banks to have their systems ready for a negative cash rate by November with the potential for the rate to be cut as early as April next year.
The cash rate was slashed from 1 per cent to 0.25 per cent in March as the country prepared to enter lockdown amid the global Covid-19 pandemic outbreak in a bid to stimulate the economy.
It has seen lending rates drop to all-time lows allowing borrowers to free up cash for spending elsewhere. But deposit rates have also fallen creating more pain for savers and driving money into shares and property.
David McLean, chief executive of Westpac New Zealand, says his bank will be ready for negative rates by the RBNZ's deadline but he doesn't believe the central bank should go there.
"My view is that negative interest rates would not be effective."
McLean said instead of stimulating the economy he believes it would damage confidence.
"The evidence we have seen from Europe is that it almost spooks people."
The European Central Bank has had a negative rate on its deposit facility since June 2014 which currently sits at -0.5 per cent.
Denmark, Sweden and Japan have also used negative rates while the United Kingdom has yet to go negative but has not ruled it out and its central bank has said it is keeping it under active review.
McLean said a negative cash rate made sense on a spreadsheet basis but in practice it would be counter-productive to what it was intended to do.
"People saving for their retirement will think they have to save a lot more."
And he said depositors could decide to move their money out of banks to look for better returns elsewhere.
"If that happens we might have to dial back on our lending."
That's exactly what the Reserve Bank doesn't want with governor Adrian Orr repeatedly calling for banks to be courageous in their lending in recent months.
McLean's warning coincides with a report on the banking sector released by Jarden analysts comparing the approaches of the RBNZ and its Australian counterpart.
It notes that the RBNZ's stance remains in contrast to the Reserve Bank of Australia which continues to view negative interest rates as being extraordinarily unlikely.
"In its simplest form, negative interest rates is a tax on reserves held with the central bank and therefore impacts the profitability of the bank.
"They (negative rates) are used to influence short-term wholesale money market rates."
However the report notes the transmission mechanism of the rate cut is uncertain as banks would likely be reluctant to charge negative interest rates on deposits, particularly retail deposits, limiting the amount they will be prepared to shave off lending rates.
"There are also other potential unintended consequences such as deposits being
switched to cash impacting funding and therefore the willingness of a bank to lend, banks
pushing out on the risk curve and perversely increased lending rates in order to maintain
In New Zealand more than 80 per cent of the mortgage market is on fixed rates with the remainder on variable rates.
Taking that into account Jarden said it expected an official cash rate cut to -0.25 per cent would impact earnings of the New Zealand arms of the big four Australian banks by 5 per cent and at a group level between zero and 1 per cent per bank.
They predicted banks would likely take a number of actions to minimise the hit to their revenue by not passing on all of the cut to borrowers on variable loan rates and dropping the interest paid on institutional deposits below zero.
New Zealand bank profits have already taken a hit this year as banks have taken big provisions for potential loan losses which are expected to result as the economy turns south, businesses go under and more people lose their jobs.
Latest figures released this week show 9.6 per cent of business loans are either on a reduced or deferred payment equating to $19.5 billion.
While 17 per cent of consumer lending, which is mainly home lending is either on a reduced or deferred payment to the tune of $50.6b.
McLean said he would prefer it if the RBNZ continued to use quantitative easing instead of dropping the official cash rate into negative territory.
Last month the RBNZ expanded its Quantitative Easing programme from $60b to $100b and extended the length of the programme to June 2022.
McLean said the only downside to QE, colloquially termed "printing money" was history showed it created inflation.
"But there is no sign of that at the moment and if it happens we know what to do about it.
"My view is the RBNZ should continue on with QE."