On the first Tuesday of every month except January, the Reserve Bank of Australia (RBA) conducts a board meeting to decide, among other things, whether to change the official cash rate. As the official cash rate has an impact on both the interest rates that our financial institutions charge on loans and interest rate paid on deposit accounts, the monthly RBA decision is often a point of contention for the average Australian. Anyone paying off a home loan or looking for the best term deposit rates available may bemoan the banks for moving interest rates around at what could be – for them – a decidedly inconvenient time.
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By the same token, banks sometimes struggle to protect their image (and their profit margins) in the wake of the RBA’s decision. So in their efforts to keep the cost of living at a reasonable level for Australians, what determines whether the RBA cash rate rises, falls or stays the same?
The factors involved in changing the RBA cash rate
For many decades, the role of the Reserve Bank of Australia has been to ensure the “economic prosperity and welfare of the people of Australia*.” Monetary policy is the means by which they attempt to control inflation and to thus promote:
- 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.
Based on how much money is circulating around the country, the RBA may raise, hold or lower the cash rate by a matter of basis points (most commonly 25 basis points or 50 basis points) to either boost demand or restrain national spending. So – how do they decide whether to raise, lower or maintain the cash rate? The main factors they take into account include:
- International economic conditions: The RBA takes into account the strength of the larger ‘global’ economy; including how overseas housing markets, consumer demand and currencies are performing. They would consider the strength of China, The United States of America, and some of the larger European countries to be of particular significance.
- Domestic economic conditions: In terms of the Australian economy, the RBA will look at:
- Our employment (and unemployment) figures – higher unemployment increases the chances of a rate cut as lower rates can boost business spending, investment and ultimately boost employment.
- Our inflation figures. Higher inflation increases the chances of a rate increase as the RBA may seek to curb consumer demand. The RBA tries to keep Australia’s inflation within a 2 – 3% band – something it has successfully done for many years now.
- Business and consumer confidence. Lower business and/or consumer confidence can increase the likelihood of a rate cut, to stimulate demand. Low confidence translates to low demand and growth.
- Household debt. Lower interest rates historically tend to boost housing prices in capital city business areas. Thus the word “bubble” is being used to describe the Sydney housing market. Other levers, such as restrictions on lending for housing investment and general tightening of lending requirements may be more effective at controlling the housing market.
- Our currency. The RBA tries to influence the strength or otherwise of our dollar via the official cash rate. If our cash rate is high in comparison to other western countries, it can strengthen our dollar as investors seeking yield put money into Australia. While a strong dollar is good for importers, it is a serious impediment to exporters.
- The stability of financial markets: The RBA take note of the performance of banks/financial institutions, and will make note of their lending and deposit account rates in particular (two of the first things to be affected by a rate change). The board also assesses how successful institutions were in accessing wholesale markets.
- Finally, they’ll review how their previous decision regarding the cash rate affected local banking. They will also give great weighting to how consistent inflation is to their projections, as well as the outlook for future growth.
The Reserve Bank Board discuss the weighting of the above indicators and choose a course of action fitting under the chartered goals in the Reserve Bank Act of 1959. These are the best indicators of future performance that reflect the sentiment of the Australian economy before news agencies and real economic action takes place.
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