How does the OCR work and how does it influence bank interest rates?

The Official Cash Rate (OCR) is the interest rate the Reserve Bank of New Zealand (RBNZ) sets for very short-term lending between banks – basically overnight money. It is reviewed seven times a year.

The OCR acts like the base price of money for the whole banking system. If the OCR goes up, it becomes more expensive for banks to borrow overnight, their funding costs rise, and floating interest rates for customers tend to rise.

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Sharon Zollner, Chief Economist, ANZ NZ

When the OCR goes down, overnight borrowing becomes cheaper, funding costs fall, and floating interest rates can drop.

And while the OCR and floating mortgage rates typically move very closely together, it’s often changing expectations about future OCR decisions that cause fixed mortgage rates to go up or down – not necessarily the current OCR.

Markets ‘price in’ future expected changes to the OCR; so, where the OCR is now, and where markets expect it to go in future, in turn, influences longer term interest rates.

This is especially the case for shorter-term rates out to around 2 years.

Beyond about the 3-year mark, global factors become more important in determining the level of interest rates.

This is why fixed mortgage rates don’t always move at the same time as the OCR — market expectations change every day.  The OCR is only one factor that determines bank lending rates, but it’s a very important one.

As the OCR and home loan interest rates drop, so do the interest rates paid to bank customers with term deposits or savings accounts.

How do banks set interest rates?

Interest rates (including rates for home loans, business loans, savings accounts, and term deposits) are determined by a number of factors.

The money banks lend to customers comes from a variety of sources, including our own customers who deposit savings with us. Anyone with a savings account or term deposit is essentially lending us their money and the bank generally pays interest in return.

We also borrow from other commercial banks and large financial institutions around the world. These financial institutions charge each other ‘wholesale’ interest rates to borrow what are generally very large amounts of money.

Banks then lend that money to their customers at a higher interest rate than they borrowed it. That is why the interest rates paid on savings accounts are lower than the rates charged for home loans.

When the cost of borrowing — whether from the OCR, domestic customers or internationally — goes up or down that impacts term deposit rates and home loan rates.

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How low might the OCR go?

The Reserve Bank uses the OCR as a tool to help achieve its goal of keeping inflation low and stable.

The Reserve Bank wants the economy to grow, but not too quickly. The growth needs to be sustainable.

A higher OCR will generally curb demand and a lower OCR will generally stimulate demand.

If the economy slows, the Reserve Bank can cut rates to make it cheaper to borrow, encouraging people to spend and businesses to expand.

But if the economy looks like it may be overheating, the Reserve Bank will hike rates to slow things down, by encouraging people to save rather than spend.

Since August 2024, the RBNZ has lowered the OCR 9 times – from 5.5% to 2.25%. This comes after New Zealand’s rate of inflation fell to within the RBNZ’s target range of 1% to 3%, giving it scope to cut the OCR and stimulate the economy.

The cuts to the OCR follow steep rises between October 2021 and May 2023, when the OCR increased by 5.25% to counter rising inflation post-Covid.

ANZ economists believe that the OCR – now at 2.25% – has reached the bottom of its current cycle.

The RBNZ cut the OCR by 25-basis points on November 26 and noted that medium-term inflation risks are “balanced”.

It noted that although economic activity was weak in the middle of 2025, it is picking up as lower interest rates encourage household spending, the job market stabilises and a lower exchange rate supports exporters.

What does this mean for my home loan?

Most borrowers with home loans can choose fixed or floating interest rates on their loan, or have a mix of both.

Floating rates and fixed rates have both fallen substantially in the past two years as the interest rate cycle has eased and banks have competed to offer their best rates.

Choosing a fixed interest rate means you lock in an interest rate, for a set amount of time.

During that time, your repayment amount stays the same. While you have certainty of repayments for a time, there may also be restrictions or fees that apply when making extra, or lump sum repayments to your loan.

Choosing a floating interest rate means your interest rate is not locked in, so it goes up or down in line with market changes, as do your repayment amounts.

While your repayments may move up and down, there may also be more flexibility to make extra repayments to your loan.

Most lenders offer the flexibility to split the loan into a mix of fixed and floating interest rates, or even a mix of different fixed rate periods to suit your circumstances.

The decision on whether to fix or not often comes down to the value someone places on having flexibility, versus having certainty about their repayments.

Talk to us for financial advice about your home loan options, and see our advice statement.

What about savers?

When the OCR and interest rates fall, home loan customers benefit as the cost of borrowing drops. However, for savers, falling interest rates mean a drop in returns for savings accounts and term deposits

This means that when setting interest rates in response to OCR changes, banks need to balance the need of borrowers and savers.

Like borrowers, savers can choose a savings account, term deposit, or other investment that meets their needs.

They might consider how much they have to invest or want to save, when or how they might need to access the money, and how much they want as a return and level of risk they’re prepared to accept as a result.

So, people need to think about whether they want to put money in a savings account, a term deposit, or some other form of investment.

Talk to us for financial advice about your savings and investment options, and see our advice statement.