With the non-stop rate hikes, the RBA and the cash rate have been the talk of the town lately. In simple terms, the Reserve Bank of Australia (RBA) serves as the central bank of Australia and sets the country’s official cash rate. Then, this rate influences the interest rate that lenders charge you.
In this article, we break down all you need to know about the RBA and how it affects interest rates, the property market and your finances.
What is the RBA?
The Reserve Bank of Australia is essential to the country’s economy. It is mainly responsible for the stability of Australia’s currency, employment and economic prosperity. To do this, the RBA monitors and controls the monetary policy by setting the interest rate on overnight money markets, also known as the “cash rate.”
Every first Tuesday of the month (except for January), the Board meets to decide the monetary policy. During these crucial meetings, the RBA has three choices – maintain the current cash rate target, decrease it to stimulate borrowing and spending or increase it to control the economy.
The GDP, inflation rate and industry and sector-specific growth rates affect the type of monetary policy strategy the RBA uses. So, the Bank affects even the smallest financial transaction you have.
Cash rate vs interest rate
The cash rate influences the cost of borrowing and lending money.
To put it simply, the cash rate is the interest that banks and lenders pay on the money they borrow from other banks in the money market. It’s also known as the “overnight cash rate” as banks lend money to each other and process transactions on an overnight basis.
On the other hand, the interest rate is the amount banks and lenders charge individuals and businesses for borrowing money. Since the cash rate affects banks’ borrowing costs, they can pass this to borrowers through the home loan interest rate.
The RBA’s cash rate history
What is the current RBA cash rate?
At its October 2022 meeting, the RBA set the official cash rate to 2.60% – the sixth consecutive hike and the highest rate in 9 years. From the historic low record of 0.1% during the peak of COVID-19, the cash rate has increased by 50 basis points from June to September and by 25 basis points in May and October.
In his statement following the announcement in October, RBA governor Philip Lowe noted that “today’s further increase in interest rates will help achieve a more sustainable balance of demand and supply in the Australian economy.”
“This is necessary to bring inflation back down. The Board expects to increase interest rates further over the period ahead.”
As the RBA struggles to balance consumer spending and the economy, Lowe tipped that rate hikes are far from over: “I think we’ll cycle around some number between 2.5 and 3.5 [per cent].”
Why does the RBA increase the cash rate?
The Bank considers several aspects when deciding the cash rate. When the Board meets each month, inflation, employment and economic growth are some of the common benchmarks they assess when calling whether the cash rate changes – increase, decrease or stay the same:
Inflation
The Bank aims to keep the “inflation target” at 2-3% to preserve the value of money and improve economic growth. Inflation is the increase in the prices of goods and services, so it’s a key indicator of the economy’s performance.
This means that if inflation in Australia is too high, the RBA may raise the cash rate to tame economic activity. On the other hand, the Bank may decrease or maintain the cash rate if inflation is below the target range to stimulate the economy.
Employment
Another factor that the Bank takes into account is the employment and unemployment rates. If unemployment gets too high, this signals the RBA to lower the cash rate to incentivise investments and household spending.
Along with the unemployment rate, wage growth also comes into play when deciding the cash rate. For example, the Bank can maintain or lower the cash rate if wage growth is slow since this pace can affect economic growth.
Economic growth
Slow economic growth can also push the RBA to lower the cash rate. Doing this promotes spending and borrowing behaviours, which in turn, stimulates the economy. This was the case when COVID-19 was at its peak in 2020, and the cash rate plummeted to a record-low level of 0.1%.
Aside from economic growth, the RBA also considers how global factors affect the country’s performance. Here’s the deal: If international circumstances, such as domestic demands and trading conditions, are weak, they can hurt the Australian economy. In effect, the RBA needs to adjust the cash rate based on what the economy needs.
What happens when the cash rate goes up?
As mentioned above, the cash rate influences almost any financial transaction you have – including loans, the property market and your savings:
How does the rate hike affect your home loan?
Banks and lenders highly base their interest rates, especially variable rate loans, on the RBA’s cash rate. So, the higher the cash rate is, the more mortgage becomes expensive. While banks are not required to pass the full rate rise or drop to you, even a small change in the interest rate can bluntly hit your repayments over the life of your loan.
Let’s say you have a 25-year loan worth $500,000 with a 5.25% variable rate. Then, the RBA increases the rate by 25 basis points. This means that your current interest rate climbs to 5.50%, and your monthly repayments change from $2,997 to $3,071.
If you want to know how the interest rates affect your repayments, you can use our home loan repayment calculator.
How does the cash rate affect property prices?
Source: CoreLogic
Since the cash rate affects the interest rate in Australia, a lower interest rate makes taking out a mortgage more attractive. This pushes the demands from potential home buyers higher, so the competition compels the market to increase property prices.
On the contrary, a higher interest rate makes loans more unaffordable to some, so housing demand weakens. The low demand and borrowers’ tendency to look for cheaper homes soften property prices across Australia.
In fact, amidst the interest rate hikes this year, the national home value fell by 1.6% in August 2022 – the sharpest monthly decline in over 39 years. Meanwhile, the most recent data showed that property prices fell by 1.4% in September.
As stated by Tim Lawless, CoreLogic’s research director, “It’s possible we have seen the initial shock of a rapid rise in interest rates pass through the market and most borrowers and prospective home buyers have now ‘priced in’ further rate hikes.”
“However, if interest rates continue to rise as rapidly as they have since May, we could see the rate of decline in housing values accelerate once again.”
How do interest rate hikes affect your savings?
Generally, the interest rates on savings accounts and term deposits move with the cash rate. If the cash rate increases, banks and lenders tend to also raise the rates on savings and term deposits. This gets inflation under control by encouraging people to save more and spend less.
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