The RBA and the official cash rate explained

Find out what the Reserve Bank’s monthly cash rate decision means for you and for the Australian economy as a whole.

RBA Explained

The Reserve Bank of Australia (RBA) is Australia’s central bank. Its role is to issue Australian currency and set our country’s monetary policy. The RBA is tasked with ensuring the stability of the Australian financial system and aims to look after both the economic prosperity and the welfare of all Australians.

The RBA is wholly owned by the Commonwealth of Australia. The bank’s board consists of up to nine members who are appointed by the Treasurer, and the current Chair of the RBA board is Glenn Stevens.

What is the official cash rate and who sets it?

One of the key responsibilities of the RBA is setting the official cash rate. This is the rate the RBA offers on overnight loans to commercial banks, and changes to the rate have widespread repercussions for the economy as a whole.

Once a month, the RBA board meets to decide whether to raise the cash rate, lower it or keep it the same. Their decision will be influenced by a wide range of factors including inflation, the performance of the Aussie Dollar, the housing market, Australia’s Gross Domestic Product (GDP) and levels of consumer confidence. The board will assess all of these factors in relation to the RBA’s goals and objectives before reaching a consensus on what to do with the official cash rate.

A look at the RBA's historic cash rate moves

If the RBA wants to encourage Australians to spend money and stimulate growth in the economy, they may look at lowering the cash rate. If they want to cool down an overheating economy, raising the rate can help control consumer spending levels across the country.

How does the cash rate affect home loan interest rates?

Banks and other lenders all over the country use the RBA’s official cash rate as the benchmark for the rates they offer on their variable rate home loans and other financial products. You may have seen or heard news stories following a rate change announcement by the RBA as economists predict when the banks will pass the RBA’s change on to their customers.

For people with home loans, rising interest rates can spell future financial pain. A higher variable rate means you’ll have to pay more interest on the money you have borrowed. If the cash rate is dropped, however, this can lead to banks lowering their interest rates, and in turn lead to lower repayments for borrowers.

The story is a little different for those people who are locked into fixed rate loans. While these borrowers are protected against any rate rises, they can’t take advantage of any rate decreases when they occur.

What other factors affect home loan rates?

While the RBA plays a big role in the determination of bank fees and costs, their decisions are only one factor. Changes in the RBA’s policy doesn't necessarily mean a parallel change in home loan interest rates. Other factors come into play when home loan rates are being determined.

One clue we have into this is through ANZ, one of Australia’s big four banks. ANZ has their own rate meeting on the Friday following the RBA decision. They also make use of their own criteria to determine these rates, which give us a clue about how other lenders decide their rates. The five criteria ANZ use when deciding on interest rates are:

  • Making sure that the returns of customer savings and investments are attractive and kept secure;
  • Coverage of the cost they pay in interest when lending out funds;
  • Keeping ANZ competitive to attract more customers and businesses to help manage costs;
  • Consideration of the country's economy and the financial standing of their customers;
  • Keeping ANZ within the regulatory requirements of the country's banking standards.

What can you do to minimise interest regardless of the RBA cash rate?

While there's not much you can do to control the cash rate or the economy, there are ways that you can minimise the impact of fluctuating interest rates on your home loan. Here are a few things you can look into to start.

Number1

Use an offset account. An offset account is a special type of transaction account that is linked to your mortgage, and you can use it as you would any other account. The main difference is that the amount in this account lessens the amount you have to pay towards your mortgage interest. If you have $40,000 in your offset account and you have a mortgage of $500,000, your interest will be based on the balance of $460,000. The more money you have in this account against your mortgage, the less your interest will be.

Number2

Extra repayments. Some lenders allow you to make extra repayments against your home loan. This is when you pay not just the loan repayment due for the payment period, but add in extra amounts. This pays off your debt faster as more of your payment goes towards the outstanding loan amount and less goes towards the interest due. Paying your loan off faster means you’ll pay less interest over the course of your loan. Note that this option may not apply for fixed rate home loans.

Number3

Find a cheaper interest rate. You can get a cheaper interest rate on your home loan in two ways. First, consider moving to a new lender. Many offer introductory rates that make the move pretty easy, but make sure that their rates after this period are still reasonable and meet your needs. The second way is to ask your current lender for a better deal, such as a discount or fee waiver. You can also ask them to give you a better loan to avoid the costs of refinancing.

Number4

Pay on time. Interest builds up when you miss a payment, and you'll end up paying for more than what you actually owe. Paying on time keeps you within budget. Also try to avoid refinancing to longer loan terms, as even though this can reduce the cost of your repayments, it can increase the interest you pay over the life of the loan.

What does the RBA have to do with inflation?

The RBA’s monetary policy aims to achieve three key objectives which are set out in the Reserve Bank Act 1959:

  • The stability of the currency of Australia;
  • The maintenance of full employment in Australia; and
  • The economic prosperity and welfare of the people of Australia.

In order to reach those objectives, the RBA sets an inflation target of 2-3% over the medium term. In other words, the RBA wants the Consumer Price Index (CPI, based on the average prices for a range of common goods and services) to increase by between 2 and 3 per cent each year.

The bank can control inflation by making adjustments to the official cash rate. For example, if inflation rises above the target rate it means that Australians are spending their money too freely and prices are increasing too rapidly. But if the RBA raises interest rates to make it more expensive to borrow money, the economy will settle and price increases will slow down. Conversely, the RBA will drop interest rates if inflation is too low and the economy is stagnating, encouraging more Australians to spend more money and stimulate economic growth.

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5 Responses

  1. Default Gravatar
    JesseApril 12, 2018

    What are the difference between interbank borrowing rates and RBA’s target cash rates ?

    • finder Customer Care
      MayApril 13, 2018Staff

      Hi Jesse,

      Thanks for your inquiry.

      Cash Rate or also known as RBA’s Interbank Overnight Cash Rate is the operational target for monetary policy. In the Australian financial markets, Cash Rate is a significant financial benchmark. Bank’s interest rates on loans, for instance, move along side with the RBA’s Cash rate. So when RBA increases Cash Rates, banks will also raise interests on their loans, savings account, term deposits, etc.

      The borrowing and lending rates meantime are the interest rates at which money may be borrowed. In Australia, it is determined by the interbank interest rates where many financial contracts are referenced to that rates. Please refer to this page for more information.

      Cheers,
      May

  2. Default Gravatar
    penelopeFebruary 8, 2018

    Who sets foreign exchange rates in Australia? How can the big four banks operate a usurious cartel when it comes to their buying and selling rates of currencies other than AUD?

    • finder Customer Care
      MayMarch 1, 2018Staff

      Hi Penelope,

      Thanks for your inquiry.

      This must be a broad topic! But generally, foreign exchange rates are governed by the RBA. Their role in the FOREX market is crucial as these rates should always be aligned to the monetary policy framework of the RBA. In terms of the buying and selling, most institutions have different operational arrangements for determining the value of Australia’s exchange rate. They may based it on how AUD exchange rate is measured. Common measures are bilateral exchange rate against the US dollar (AUD/USD) and trade-weighted index (TWI). If you want to learn more about FOREX rates, please refer to this guide from RBA page.

      Hope this helps.

      Cheers,
      May

  3. finder Customer Care
    ShirleyNovember 10, 2016Staff

    Hi Colin,

    Thanks for your question.

    Savings accounts interest rates generally move in line with the RBA cash rate. If you see the RBA cash rate decrease, savings accounts rates generally go down as well.

    Cheers,
    Shirley

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