Earlier in May, the Reserve Bank of Australia (RBA) lifted the cash rate by 25 basis points to 0.35% in an effort to control inflation, which is has been rising at a significant speed over the past two decades.

The cash rate was then increased by 50 basis points to 0.85% in early June, and another 50 basis points in July to 1.35%.

While you may know the cash rate generally equals an increase in interest rates, what does it all mean and how does it affect you?

Each month (excluding January), the RBA decides whether the official cash rate will remain the same or move up or down, with most changes made in 0.25% increments. When the cash rate changes it affects not just the banks, but the whole economy.

To first understand what we mean by 'cash rate', and why it moves, let's take a step back.

The RBA is Australia's central bank and is accountable for conducting monetary policy which contributes to the stability of the Australian dollar and ensures a prosperous economy. Monetary policy involves setting the interest rate at which banks can borrow from the RBA, referred to as the 'cash rate'. This rate sets a target for the rest of the country through affecting the interest rates the banks pass on from the RBA to customer households and businesses, however, this is not the only factor used by banks to determine interest rates on loans and interest bearing deposit accounts.

The RBA's decision to move the cash rate is influenced by a number of factors including inflation, level of employment, economic growth, performance and stability of the Australian dollar, the international economy, and consumer and business confidence.

When the cash rate is low, like it has been for the past 20 years, it encourages consumer spending, increases wealth through more disposable income, and lowers the interest rate on loans making them more achievable to pay off.

Due to the 'wealth effect' a low interest rate creates, assets prices such as the housing market, along with other goods and services, can start to inflate. With more disposable income, plus low interest repayments, more people can take advantage of buying a home or investment property.

Low interest rates can also negatively impact people who may need to live off the interest they earn on their savings, such as retirees. If they're earning less interest on their savings, overall spending is reduced which can impact and slow the economy.

Higher interest rates on the other hand will increase the cost of borrowing, resulting in consumers spending less. This tends to moderate the economic growth and reduce pressure from inflation. With the price of goods and services on the rise, a higher cash rate will reduce the pressure of supply and demand.

While banks and lenders are not obliged to change their interest rates when the cash rate moves, most will take any cash rate changes into consideration and either lower their interest rates in line with consumer expectation or increase interest rates to pass on any increased funding costs to consumers.

Learn more about Auswide Bank home loan packages

This information provides general advice only. We do not provide advice about this product based on any consideration of your personal objectives, needs or circumstances. Some Information sourced from rba.gov.au.

Published: Friday, 24 Jun 2022