What happens when the RBA alters its interest rates?

July 10, 2021 01:08 AM AEST | By Team Kalkine Media

What happens when the RBA alters its interest rates? — Image source: Doubletree Studio, Shutterstock.com

How does RBA use Interest rates?

The interest rate decided by the central bank affects overnight loans in the money market. May times, banks need to go to money markets to obtain overnight loans. It is done to maintain balances for transactions. These loans carry the RBA's interest rate. Therefore, a low RBA interest rate (sometimes called a 'cash rate') drives the business of banks. If the cost of taking out a loan by a bank is low, they are likely to take more risks by lending it further to the public.

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What factors cause a change in the RBA’s cash rate?

Changes to the official cash rate are based on the outlook for economic growth and inflation. The RBA targets inflation to be in a certain range in a particular economic cycle. If inflation is towards the top end of this range or rising, it signals that the RBA may lift the official cash rate. Similarly, if inflation is at the low end and other indicators such as growth and employment are weaker, it signals the RBA to cut the official cash rate. In such a situation, RBA targets increased public spending generating higher demand on given supply, causing a general price rise.

The RBA also looks at important international factors that drive the performance of the Australian economy. The broader global economic outlook is also considered given its importance for business confidence, share market movements and broader economic activity.

What is RBA’s current interest rate?

On 6 July 2021, RBA left its cash rate target at a record low of 0.1 per cent. As per the RBA Governor, it is not planning an interest rate rise before 2024. An increase in the cash rate is dependent on the data based on inflation outcomes and other inputs. Inflation and wage outcomes have been lower in Australia compared to other places. Therefore, as per RBA, the scenario will not need a lift in the cash rate until 2024 in Australia.

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Does RBA’s interest rate change affect investment flow?

If the RBA keeps its cash rate constant month on month, it indicates that the RBA is putting off changes to the cash rate. If Interest rates rise, people with savings get higher rates of return. For those holding fixed interest investments such as government and corporate bonds, interest rate increases may mean a fall in the value of bonds. On the other hand, the Australian dollar generally strengthens against other currencies when foreign investors are attracted to a higher yield. As a result, they drive up demand for the Australian currency. Thus RBA's interest rate changes do affect investment in different types of assets.

Why is RBA not increasing interest rates?

Australia's strong economic growth rebound and large fall in unemployment have not translated into pay rise for the public. It is because there haven't been any upside movements in wage rates and inflation. Also, as long as the Australian border remains closed, businesses will not get the people they need to do the investment and expansion. It will mean that Australia will probably be one of the least developed economies to start raising interest rates to post COVID-19, as it would require getting wages growth back above 3 per cent.

Also read: ASX ends marginally higher ahead of RBA’s policy decision; banks, miners weigh

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