Finance

How can a stagnant RBA interest rate affect you?

Firstly, a quick synopsis. We constantly read and hear about the RBA’s interest rate and how it will affect the economy, but how many of us know what it is?

Who are the RBA?

The Reserve Bank of Australia is a body corporate entirely owned by the Commonwealth of Australia. It is Australia’s central bank and its main role is to maintain the stability of the country’s financial system, with the public face of its role made manifest through its role in setting the cash rate. The cash rate is announced after each RBA board meeting, which is usually once a month, apart from January.

Reserve Bank of Australia

What is the RBA interest or ‘cash’ rate?

Despite some common misconceptions, the RBA interest rate does not dictate the interest rates individual banks set for their loans (whether they are business loans, personal loans or home loans). Instead, the RBA interest rate is that which effects overnight loans in the money market.

How does this affect banks? Because they sometimes need to take out overnight loans to help fund their various transactions. Yes, banks sometimes run out of cash and that’s why they take out overnight loans, which have an RBA interest rate.

So, a low RBA interest rate (sometimes called a ‘cash rate’), in theory, drives further business by banks because they know that if they need to take out a loan to fund their own transactions they won’t have a large interest rate attached to it. If the cost of taking out a loan by a bank is low, then they are likely to take more risks through lending to more businesses and individuals and driving the circulation of money through the economy. Simple!

Cash in a wallet

How does a static interest rate affect you?

“Prior to the GFC, the cash rate had been steadily increasing and was at 7.5 per cent in the middle of 2008.” says CEO of realestateVIEW.com.au, Enzo Raimondo, “However, since 2008 it has fallen dramatically and was at 1.75% as of July 2017. The RBA have attempted, successfully, to keep the cash rate relatively steady for nearly a year, but we have seen that this does not mean that the status quo remains the same within the economy.

“Certain banks, including the big four, increased loan rates in early 2017 in answer to their own projections for what they saw as an imminent rise in the RBA cash rate, newly imposed regulations on their lending to curb high risk loans, and of course, the surging price of housing.”

If the RBA keeps the cash rate at the same level as the previous month, this usually indicates that it is either putting off making any changes to the cash rate to see whether the economy changes or that there are relatively equal forces pushing and pulling the cash rate so that it remains the same (e.g. unemployment rates, GDP, the value of the Australian dollar).

If you have been saving for a home, you may have noticed that the interest rate on your savings account has decreased over the past several years and that saving for a deposit has never seemed harder. You are not alone, as housing affordability is a huge concern for new home owners and the board of the RBA alike. A static cash rate does instil a certain level of confidence in lenders, however, so you may find it easier to secure a loan than if the cash rate had been increased.

As a first home owner, you can enjoy the relative stability a static cash rate supports and use this stability and lending confidence to extend upon your equity, to in turn reinvest it. This itself has had an influence on property prices in Australia as homeowners have invested equity into renovations, driving up the price of their homes, or invested it in additional properties for investment.

When the RBA cash rate remains the same, this generally has the biggest influence on creating or maintaining consumer and lending confidence, as any deviations in the cash rate, whether up or down, create speculation and a level of uncertainty in the market as to the motivations of the RBA and what it says about the future of the economy.

READ MORE: How does an increased RBA interest rate affect you?

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