Analysis: RBNZ’s Path Shows Interest Rate Swaps Preferred Unconventional Tool

By Sophia Rodrigues

The Reserve Bank of New Zealand could use a different form of forward guidance before it pushes the official cash rate below zero but once it reaches that point interest rate swaps is likely to be its preferred unconventional policy measure.

In a speech Tuesday, RBNZ Governor Adrian Orr outlined a set of tools it could use once the OCR reaches the effective lower bound but stressed it still does not need to use them. The RBNZ also issued a separate document outlining the key principles it would use to assess the alternative tools.

Significantly, Orr reiterated the effective lower bound for the OCR may be below zero, and the RBNZ is “near ready” to implement zero or slightly negative interest rates in its operations. This contrasts with the Reserve Bank of Australia which has made clear that 0.25% is the effective lower bound for its cash rate.

A different form of forward guidance would mean the RBNZ might publish a forecast of the “shadow short rate” which shows the combined stimulus from the OCR and other monetary policy tools through interest rates.

The RBNZ could also commit to keeping monetary policy expansionary for longer, even if it runs the risk that inflation would eventually rise above 2% or employment rises above sustainable level.

Once the OCR reaches the effective lower bound, the RBNZ is likely to consider interest rate swaps where it would receive fixed rates and pay floating rates to financial market participants. This would reinforce forward guidance while also reducing market interest rates, the RBNZ said.

Other unconventional options on the table include purchasing government bonds which according to RBNZ, would have more of an effect on longer-term interest rates over two-year term, that are important for mortgage and business lending.

The purchase of foreign currency or assets would be useful to reduce the New Zealand dollar and to increase NZD liquidity, if needed, the RBNZ said.

Term lending would be useful to support monetary policy transmission through the banking sector. This would be collateralized long-term loans to banks provided with conditions that require banks to increase their credit supply.

Orr said that choosing the most appropriate tool or combination of tools, and policy coordination would depend on the situation at hand.

“For example, if an economic disturbance resulted in significant disruption to the functioning of the financial system, this would naturally alter the stylised ordering outlined above,” he said.


The principles behind the choice of tools indicate interest rate swaps would be its first choice as I wrote in a story last week.

Interest rate swaps would not only help reinforce forward guidance but also help in lowering mortgage rates, which is one of the key channels for monetary policy in New Zealand.

But in the current situation where the OCR is at 1% and still far from the effective lower bound, it is possible the RBNZ could still use some form of unconventional policy tool to deal with risks of economic slowdown due to coronavirus outbreak.

Since managing credit stress and providing relief to affected businesses and individuals would be a priority, some variant of term lending to banks might be an option.