Recently there has been a bit of discussion in the mainstream about interest rates potentially rising sooner than expected. ASB yesterday increased its five-year term deposit rate by 75 basis points to 1.75 per cent. However, today you’ll see why it is the real interest rate that we need to keep track of…
Table of Contents
- How Do Real Interest Rates Differ From the Overnight Cash Rate (OCR) that the Reserve Bank Fiddles With?
- Why is the “After Inflation” Interest Rate So Important?
- So What is the Real Interest Rate in New Zealand Currently?
- How do you Calculate the Real Interest Rate?
- The Relationship Between Gold and Real Interest Rates
- But What if We Get Higher Inflation and So Interest Rates Start to Rise?
- Where to Next for Real Interest Rates in New Zealand?
Estimated reading time: 8 minutes
Interest Rates in New Zealand remain at historic lows, with the Reserve Bank slashing the Official Cash Rate (OCR) by 0.75% back in March 2020.
What will the Reserve Bank of New Zealand do in coming months? Are rates likely heading even lower? Or will the next move by the New Zealand central bank be up?
Our guess is any move higher is still a long way off.
Obviously the interest rate has a bearing for those New Zealanders with a mortgage and businesses with loans. But rather than focussing on the central bank announcement every quarter, we think there is a much more important interest rate to keep an eye on.
That is, what is the current “Real Interest Rate” in New Zealand?
How Do Real Interest Rates Differ From the Overnight Cash Rate (OCR) that the Reserve Bank Fiddles With?
What are real interest rates?
The real interest rate is the nominal interest rate, less the current rate of inflation.
The nominal interest rate simply refers to the quoted interest rate on the likes of a government bond or central bank set interest rate. The current rate of inflation is shown by the government consumer price index (CPI).
Why is the “After Inflation” Interest Rate So Important?
Why is this so important?
Because it shows you what return you are getting on your money after inflation. When this number gets below 2% and in particular below zero (also known then as a Negative Real Interest Rate) this is when it is an especially good time to hold gold.
Why is that?
Because when interest rates are very low, there is then no “opportunity cost” in holding gold. This simply means you are not missing out on returns elsewhere – such as interest in a bank account.
As the gold haters like to remind you, gold pays you no interest. But when the bank pays you no interest (or next to none) it makes sense to swap your cash for gold instead. Because in this kind of environment, you stand a much better chance of maintaining your wealth and your purchasing power with gold.
Likewise, even when nominal interest rates are higher, if interest rates are higher still, you are also getting no return after inflation.
The chart below shows this relationship between US real interest rates and the gold price in US Dollars..
So What is the Real Interest Rate in New Zealand Currently?
Previously we’ve been able to simply refer to the excellent charts available on Greshams-law.com. These had the benefit of plotting real interest rates in various countries including New Zealand. Unfortunately that site no longer seems to be running. So the most up to date chart we have from them only runs until 2012:
How do you Calculate the Real Interest Rate?
The definition from Greshams-Law.com for ‘real’ interest rates, was the short-term inter-bank rate minus the year-on-year growth in the consumer price index. The CPI rate comes from the OECD statistics. Therefore this data is only as good as each government CPI measure, which likely means inflation is actually higher than this!
Sometimes we see other measures such as a 3 month bond or even a longer dated bond used. These will of course usually give a slightly higher interest rate than the interbank lending rates which are an overnight rate.
However the difference is not very much. Right now it is only 0.04% between the interbank lending rate and the 90 day Bank Bill Rate in New Zealand (Source). The important thing we are looking for in analysing real interest rates is the direction they are heading – the trend.
So we’ll stick with the interbank rate. It also has the advantage of going a long way back compared to some New Zealand government bond data.
The below chart shows real interest rates along with the local New Zealand Dollar gold price each quarter. (A reminder, real interest rates are the interbank lending rate, less the change in the Consumer Price Index (CPI) from a year prior). Our chart only goes back to 1985. As that is as far as the RBNZ monthly data on wholesale interest rates goes. The latest CPI data available is for the December Quarter. So the chart runs until December 2020.
Here is the chart as of September 2019 to show how much more negative rates have become in the past 15 months since then.
Source: RBNZ, Stats NZ, World Gold Council
The Relationship Between Gold and Real Interest Rates
To our eye there appears to be a pretty solid inverse relationship between real interest rates and the gold price in New Zealand dollars.
Throughout the 1980’s and 90’s the gold price was fairly flat or down, as real interest rates remained high. Averaging perhaps around 5%.
In the early 2000’s gold started to rise as real interest rates moved down towards 2.5%. Then they fell sharply, first down to zero and then even lower to -2.50%. This was when the NZD gold price really moved higher. Going from under $1000 to peak at over $2100 in 2011.
But then the “after inflation interest rate” started to head higher. During this time gold was correcting lower. In 2015 the real interest got back briefly above 3% before turning lower. This is also about the time when the NZD gold price also started to resumed its upwards trend.
Since then the inverse relationship has continued.
You can see that over the past few years, the NZ dollar gold price has been trending up, while real interest rates have been trending down. This is the very relationship we discussed earlier. That is, when real interest rates are negative – or close to it – gold generally performs well as there is no opportunity cost in holding gold.
Real interest rates once again dipped into negative territory in recent years. In 2020 they went even more negative. While gold in NZ Dollars hit a new record high over $3000.
Are you already worrying about low returns in the bank? These numbers show they are already negative, especially once withholding tax is taken into account.
But What if We Get Higher Inflation and So Interest Rates Start to Rise?
The talk from economists has recently switched to when will we see the Reserve Bank raising interest rates.
This is what happened in the 1970’s – interest rates were very high, in the teens in fact. But inflation was even higher and so gold was rising while nominal interest rates were rising. But in fact real interest rates remained negative.
So ignore any comment about how rising interest rates are bad for gold as it is the Real Interest Rate that matters.
Where to Next for Real Interest Rates in New Zealand?
In recent months we have seen the gold price falling, along with real interest rates getting less negative. They have dropped from a high of almost -2% in early to mid 2020 to now be just above -1%. This has prompted some to think the bull run in gold is over.
However we’d say this a bit premature.
It seems unlikely that the OCR will be lifted anytime soon. In fact the RBNZ says they are prepared to put up with bouts of inflation to achieve their targets.
But as we discussed recently, the odds of inflation rising in the future seems to be higher than most people would expect. See: Inflation in 2021 and Beyond: What’s Different to 2009? While the current inflation rate remains low at 1.40%, future inflation expectations have been picking up lately.
If the government cranks up spending, that may further add to inflationary pressures. That would produce even lower real interest rates. Much like in the 1970’s (see the US chart from earlier, where real rates got as low as -6%).
So if interest rates remain close to the current levels, but inflation begins to pick up, then the real interest rate could end up even more negative.
We’d say it makes sense to keep an eye on this chart. In the long run real interest rates may get even more negative than they have been.
So it’s likely that gold in NZD will remain the place to be while this is going on. While it might not be a straight line higher, we think there will be much higher gold prices in New Zealand dollars to come yet. Have you bought gold yet? Check the range of gold and silver to buy here.
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Editors Note: This article was first published 8 May 2012. Last updated 2 March 2021 to include all new charts with latest New Zealand data. Plus new commentary.