What is the cash rate and how does it affect you?
The board of the Reserve Bank of Australia currently meets eight times a year, and after each of these meetings, announces whether the official cash rate will remain the same or move up or down, and this announcement has important ramifications for banks, lenders and everyday Aussies. So what exactly is the cash rate, how does it work, and how can it affect you?
The board of the Reserve Bank of Australia currently meets eight times a year, and after each of these meetings, announces whether the official cash rate will remain the same or move up or down, and this announcement has important ramifications for banks, lenders and everyday Aussies. So what exactly is the cash rate, how does it work, and how can it affect you?
What is the cash rate?
The cash rate is a figure set by the Reserve Bank of Australia (RBA), representing the interest that banks and lenders have to pay on the money they borrow. The RBA itself describes the cash rate as the “overnight money market interest rate”. The reason for this is that banks frequently lend money to each other and process these transfers overnight, and the cash rate is the amount of interest that banks have to pay to borrow money in these transactions.
Current RBA cash rate: 4.35%
At its March 2024 board meeting, the Reserve Bank of Australia (RBA) left the cash rate unchanged at 4.35%. This is the highest point that the cash rate has been set in the past 11 years. The bank’s board formerly met on the first Tuesday of each month, with the exception of January, but has since cut its number of meetings to eight per year. The board now meets over two days and makes its announcements on a Tuesday, and the next cash rate call can be expected on Tuesday May 7. Economists speculate that the rate will hold steady for several months before anticipated cuts at the end of 2024.
What is the RBA and what does it do?
The RBA is Australia’s central bank, and its role is to make monetary policy and maintain the strength of the nation’s financial system. According to its own charter, the board of the RBA has three key duties. Namely, the bank’s board is required to contribute as best it can to 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.
One of the key roles of the RBA board is to set the official cash rate. At its regular meetings, the board meets to discuss monetary policy, including whether or not to change the cash rate. At these meetings, it can do one of three things – lower the cash rate, with a view to stimulating borrowing and spending in the economy, raise it to try and keep inflation under control, or keep it at the same level.
How often does the RBA change the cash rate?
Though the board of the RBA has the ability to change the cash rate at each of its meetings, the increase announced in May 2022 was the first change in more than a year. The previous change was back in November of 2020, when the RBA cut it from 0.25% to 0.10%, in an attempt to mitigate the ongoing effects of the COVID-19 pandemic.
The cash rate had held steady since then, until the increase to 0.35% in May 2022 which was followed by increases of 50 basis points in June and July. It has risen with each RBA meeting since, with the exception of April 2023, when the board held the cash rate steady over the Easter period, July 2023, through August, September and October 2023. The RBA raised the cash rate again in November 2023, and held it steady in December.
What’s the RBA cash rate history?
Up until the increases that began in 2022, the RBA cash rate had been in decline since November 2011, when the figure was cut from 4.75% to 4.50%. That’s a far cry from some of the highs the cash rate achieved in the last century when it reached its highest at 17.50% in January 1990. It wasn’t until September 1991 that the figure dropped below 10% to 9.50%.
Why does the RBA change the cash rate?
The RBA takes a number of things into account when considering whether to change the cash rate. Generally speaking, factors that influence the RBA to move the cash rate include inflation, employment, and the growth rate of the Australian economy.
Inflation
Inflation refers to the increase in price of items from one point in time to another; it is typically measured on a quarterly or annual basis, and is a key indicator of economic performance.
The RBA has a medium-term inflation target of 2% to 3%, and if inflation gets too high, it might raise the cash rate to assist Australians in maintaining their purchasing power, as was the case with the 2022 rate hikes. If inflation is below that target range, the RBA may be more inclined to leave the cash rate alone or cut it.
Employment
The level of employment is a major indicator of how an economy is performing. If unemployment rates get too high in Australia, the RBA may decide to lower the cash rate, in order to stimulate investment and spending in the economy, which might thereby serve to create new jobs.
But when it comes to jobs, the unemployment rate isn’t the only thing the RBA considers. Even if unemployment is low, the RBA may choose not to raise the cash rate if wage growth is also low, since sluggish wage growth tends to go hand-in-hand with slow economic growth and low inflation.
Economic growth
The RBA states that economic growth in Australia is typically measured as a percentage of the nation’s gross domestic product (GDP) – the total value of all goods and services produced here annually. If economic growth is slowing down, the RBA might choose to lower the cash rate as a means of economic stimulus. This was the case in 2020, when the board set the rate at its lowest point ever in an attempt to mitigate the economic effects of COVID-19. Doing this might, in theory, increase the incentive for consumers and financial institutions to spend and borrow money, which might then set the economy on an upward trajectory.
Does the cash rate affect the banks’ interest rates?
While the RBA’s monthly cash rate announcements are important, and do partly influence how banks and lenders set their interest rates, they are not the only factor that goes into the decision. As the RBA explains it, there are three main factors that can go into how banks and lenders set their interest rates, and decide whether to put them up or down. These three factors are funding costs, competition from other banks for borrowers, and the risk of default from existing borrowers.
Funding costs
Funding costs are the interest rates that banks pay to borrow money (including from each other, which is where the cash rate comes in), and also to the people who deposit savings with them. If funding costs increase, a bank may wish to increase the rates it charges borrowers in order to remain profitable. If lending rates go up, though, borrowers may in turn be more cautious and borrow less. It is therefore important for banks to balance these considerations to maintain profitability.
Competition from other banks
Banks and lenders exist in a competitive marketplace in Australia, and as such, in order to maintain profitability, they must compete for borrowers’ dollars. This competition can influence the movement of interest rates, insofar as banks and other institutions may choose to cut their lending rates (or raise interest rates on savings accounts and term deposits) in order to attract new customers and refinancers.
Risk of default
Banks and lenders are typically concerned with risk, so before lending money to a prospective borrower, they will assess the risk of this borrower potentially going into default or otherwise being unable to repay their loan. If a bank or lender perceives a certain type of lending to be riskier – say, for example, lending to investors who plan to purchase properties to rent out to tenants – they will often raise their interest rates on that particular type of lending.
How does the cash rate affect home loans?
While the cash rate has no direct impact on home loan interest rates, and banks and lenders are not obliged to follow the decisions of the RBA, most will typically keep an eye on the cash rate and it will form part of their decision-making when setting their own interest rates. When the cash rate is low, banks and lenders may well be expected to offer lower interest rates to new homebuyers and refinancers in the housing market. A rise in the cash rate, however, could likewise mean home loan rates going up, as banks and lenders absorb and seek to pass on the cost of the rise.
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How does the cash rate affect deposits?
Generally speaking, the movements of the cash rate up or down will have a similar effect on the interest rates on savings accounts and term deposits. If the cash rate rises, then banks might raise the interest rates on deposits, which might in turn encourage people to deposit their money in savings with a view to earning interest. Conversely, though, if the cash rate is low, then banks are likely to set the interest rates on deposits low, meaning it is likely people will earn less interest on their savings.
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This article was reviewed by our Senior Finance Journalist Michael Lund before it was updated, as part of our fact-checking process.
Alasdair Duncan is a Senior Finance Journalist at Canstar, specialising in home loans, property and lifestyle topics. He has written more than 200 articles for Canstar and his work is widely referenced by other publishers and media outlets, including Yahoo Finance, The New Daily, The Motley Fool and Sky News. He has featured as a guest author for property website homely.com.au.
In his more than 15 years working in the media, Alasdair has written for a broad range of publications. Before joining Canstar, he was a News Editor at Pedestrian.TV, part of Australia’s leading youth media group. His work has also appeared on ABC News, Junkee, Rolling Stone, Kotaku, the Sydney Star Observer and The Brag. He has a Bachelor of Laws (Honours) and a Bachelor of Arts with a major in Journalism from the University of Queensland.
When he is not writing about finance for Canstar, Alasdair can probably be found at the beach with his two dogs or listening to podcasts about pop music. You can follow Alasdair on LinkedIn and Twitter.
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