How does the RBA cash rate affect me? Understanding the basics

It is almost impossible to not notice that recently (or every so often before then), the recurring theme of “cash rate increase” or “RBA rate rises” are all headlining Australian business and economic news. While it might be hard to digest how all of this impacts the Australian economy, we have put together a summary of key information that beginner investors should be aware of, to make the most out of the cash rate increase.

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 from the RBA.

According to the RBA, the cash rate can be defined as “overnight money market interest rate”. 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.

As the central bank, the RBA functions as the primary decision-maker when it comes to monetary policy. According to its charter, the RBA’s goal is to promote:

  1.  the stability of the currency of Australia
  2.  the maintenance of full employment in Australia
  3.  the economic prosperity and welfare of the people of Australia

On the first Tuesday of every month (except January), the RBA meets to discuss whether the official cash rate should be increased, decreased, or left as it is. Their decision is announced at 2:30 pm on the day of the meeting and any change to the official rate will take effect the next day. At its May 2023 board meeting, the RBA raised the cash rate to 3.85%. This followed a pause in the month of April, the first reprieve for Aussie borrowers since a series of hikes beginning in May of 2022.

What impact does the cash rate have?

There are significant impacts on various aspects of the economy, including:

(1) Borrowing costs: The cash rate impacts how expensive it is for businesses and individuals to borrow money from banks. High cash rate can lead to a decrease in borrowing, as well as a slowdown in economic activity, particularly in sectors that rely heavily on borrowing. This can lead to higher interest rates on loans, including home loans and credit cards.

(2) Lower consumer spending: As borrowing costs increase, consumers may become more price sensitive and cautious about their spending. This can lead to a reduction in consumer spending and postponement of purchasing of big ticket items, which can slow down economic growth in general and particularly affect consumer discretionary sectors.

(3) Strengthening of the Australian dollar: The cash rate increase can make the Australian dollar more attractive to foreign investors, as they can earn a higher return on their investments. This can lead to an appreciation of the Australian dollar, which can make Australian exports more expensive and less competitive in international markets.

(4) Reduction in inflation: Increasing the cash rate can help to control inflation by reducing demand and slowing down economic growth. The RBA aims to keep inflation within a target range of 2-3%. An increase in the cash rate can help to reduce inflationary pressures in the economy by making it more expensive to borrow and spend money. This can lead to a decrease in the cost of goods and services, as well as a decrease in wage growth.

On a positive note

While cash rate increases are generally frowned upon, the good news is, savings accounts for the most part move in line with the cash rate. This means that if the cash rate goes up, you can expect much more attractive returns on your savings.

The hope is to keep inflation from getting out of hand by encouraging people to save more and spend less. On the other hand, if the cash rate goes down, interest rates on deposits will go down with it. And while banks aren’t guaranteed to pass on the full cut to their mortgage customers, they won’t hesitate to pass it onto savers.

Overall, the impact of a cash rate increase can be complex and vary depending on a range of factors, including the current state of the economy, the level of debt held by households and businesses, and the actions of other central banks around the world. On a smaller scale, how one could benefit or become disadvantaged from cash rate increases will depend on individuals’ circumstances, such as their income, job security, current borrowings, and saving power.