What Is the Cash Rate?
The cash rate is the interest rate banks pay on unsecured overnight loans to each other. Set by the Reserve Bank of Australia (RBA), it influences the interest rates that banks charge on the money they borrow.
Sometimes called the “overnight money market interest rate,” the cash rate governs transfers between banks, typically processed overnight. This rate determines how much interest banks pay on these transfers.
In response to COVID-19’s economic impact, the RBA lowered the cash rate to a record low of 0.10% in November 2020. Initially, Philip Lowe, the RBA Chairman, suggested the rate wouldn’t increase until 2024. However, due to high inflation, the RBA raised the cash rate in May 2022. The RBA continued these hikes, with another 25 basis point increase in May 2023, bringing the rate to 3.85%, the highest in 11 years.
Who Decides the Cash Rate?
The RBA meets on the first Tuesday of each month (except January) to review and set the official cash rate. The RBA takes several factors into account, including the housing market, inflation, employment levels, and the overall health of the Australian economy. International trends and the strength of the Australian dollar also play a role.
Following each meeting, the RBA announces any changes to the cash rate. This new rate takes effect the following day. The RBA’s decision directly influences the interest rates banks charge their customers for loans.
How Does the Cash Rate Affect Interest Rates?
The RBA’s decisions on the cash rate have a major impact on the interest rates consumers pay. Although the cash rate is only one part of Australia’s economic policy, it plays a crucial role in determining borrowing costs for banks.
When the cash rate rises, it becomes more expensive for banks to borrow money. As a result, banks typically pass on these higher costs to consumers by increasing interest rates on loans. If the cash rate drops, banks may lower their interest rates on both loans and savings products.
Banks adjust their rates in response to cash rate movements, but they are not legally required to do so. However, these fluctuations provide banks with greater flexibility to change their own rates.
