As the pandemic persists, New Zealand considers negative interest rates

New Zealand is considering negative interest rates, as it grapples with the severe economic impact caused by the coronavirus pandemic.

In its interest rate decision this week, the central bank maintained its official cash rate at 0.25%, but also raised the possibility of going into negative territory.

"The severe global economic disruption caused by the pandemic is persisting. Any significant change in the global and domestic economic outlook remains dependent on the containment of the virus, which is highly uncertain as evidenced today by the return to social restrictions in New Zealand," it said in a statement on Wednesday.

Speaking to CNBC's "Squawk Box" on Friday, Reserve Bank of New Zealand Governor Adrian Orr said the option of negative rates would not be used on its own, but rather, as part of a package of measures to tackle the health crisis.

"Negative rates won't be on their own, which is why we talked about a package of measures because any one instrument will achieve only certain amount of effectiveness on its own," he said.

 "We're still very confident monetary policy is effective, but it's not the main game in town," Orr said, adding that fiscal policy too would need to be tapped upon.

People wait for a walk-up Covid-19 test on August 14, 2020 in Auckland, New Zealand. Covid-19 restrictions have been reintroduced across New Zealand.

Fiona Goodall | Getty Images News | Getty Images

New Zealand's economy shrank 1.6% in the March quarter, the largest drop in 29 years. The decline is expected to be worse in the June quarter, according to its finance minister.

The country was virus-free for more than 100 days, before seeing a resurgence of coronavirus cases in its largest city, Auckland, in recent weeks. The development prompted authorities to lock down the city again on Wednesday, imposing movement and travel restrictions for three days. Since then, more cases have been confirmed and linked to the new cluster.

New Zealand will decide today whether to ease or extend the latest lockdown, according to Reuters.

Lowering interest rates would typically slash lending and deposit rates, which tends to encourage businesses and individuals to invest and spend more — actions that help the economy to grow.

Negative interest rates should — in theory — have the same effect. Some economists said that when commercial banks have to pay to deposit funds with the central bank, instead of earning an interest on those reserves, they should be encouraged to loan out that money instead.

However, some studies found that negative interest rates did not work in Japan and some European economies, and in fact, they reduced bank profits.

When asked how ready New Zealand banks were for a move to negative rates, Orr said the "vast bulk of banks are ready."

He added that he did not want to be "held hostage at all" by banks saying they weren't ready.

"The banks themselves know that they are on notice to be operationally ready by at least December," he said. "We've got time to consider the education, we need the operational capability …  and the monitoring that we need to see … bank  just how effective (it is)."

— CNBC's Yen Nee Lee contributed to this report.

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