What is the cash rate and how does it affect you?

The Reserve Bank of Australia.

Official interest rates, also known as the cash rate, have been the source of countless news stories in recent years, with each cut generating plenty of chatter about the state of the economy and the direction it’s heading.

But what do changes to the cash rate mean for everyday Australians, particularly those with a home loan or savings account? We take a look at how the cash rate works and how exactly it affects you.

What is the cash rate?

The cash rate reflects the market interest rate on ‘overnight’ funds, which are the funds banks lend to one another on an overnight basis to meet their daily cash needs.

But the cash rate is more than just some insider metric — it serves as a benchmark rate for everything from mortgages and savings accounts to the exchange rate, making it an important tool for managing national monetary policy.

When the RBA makes changes to the cash rate, it has knock-on effects on many of the moving parts of the economy, like spending, investment, employment and inflation.

That’s why when the economy is strong and high demand is pushing up the price of goods, the RBA might decide to raise the cash rate to slow things down a bit and make sure inflation stays within a healthy range.

If, on the other hand, the economy is weak and demand is low, the RBA might lower the cash rate to encourage spending and investment, giving the economy the boost it needs.

What is the RBA and how does it control the cash rate?

The Reserve Bank of Australia is the country’s central bank, and it functions as the primary decision-maker when it comes to monetary policy. According to its charter, the RBA’s goal is to promote:

a) the stability of the currency of Australia
b) the maintenance of full employment in Australia
c) 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.

In the lead-up to a cut, the RBA will usually try to set the stage. It has a reputation for being a cautious organisation, and doing anything too abrupt would be out of character. Quick decisions made without first paving the way for them is generally what happens when there’s an emergency. 

What influences the RBA’s decision?

There are a number of items on the agenda when the board meets each month. Here are just some of the things it takes into account when deciding what changes to make to the cash rate, if any.

Inflation

The RBA has a flexible medium-term inflation goal of 2-3%, meaning that while inflation is allowed to fall outside this range, at least temporarily, it should remain within 2% and 3% on average. If inflation is too high, the RBA might raise the cash rate to ensure Australians retain their purchasing power.

Employment

The level of employment (and unemployment) in the country is a solid indicator of how well the economy is performing. If unemployment is on the rise, the RBA might choose to lower interest rates to stimulate spending, investment, and the creation of new jobs.

Economic growth

If economic growth has slowed or is on the way down, the RBA might lower the cash rate to bring demand back up. This typically works by reducing the incentive to save and increasing the incentive to spend and borrow. 

The international economy

Global financial conditions also feature prominently in the RBA’s deliberations. Strong economic growth overseas can mean increased demand for Australian products. But if overseas conditions are weak, or if there are tensions among our major trade partners, it could hit Australia’s economy hard.

How does the cash rate affect home loans?

The cash rate is one of the main factors that banks take into account when setting their variable home loan interest rates, so any increases or decreases will usually flow through to mortgage holders.

That said, it’s not the only factor, and in the case of a cut banks are by no means obligated to pass it onto their customers in full. We saw this during the last two RBA cuts, when the majority of lenders reduced fixed rates but left variable rates unchanged.

Nonetheless, even a modest decrease in interest rates can translate to a sizable reduction in borrowers’ monthly repayments, and thousands saved over the life of a loan. The below graph illustrates how the average variable rate for different borrower types has moved in line with the cash rate over the years.

Lower interest rates also make taking out a mortgage much more attractive, which is why RBA cuts tend to be followed by a rush to enter the property market. The resulting competition is known to drive up property prices quite a bit.

How does the cash rate affect deposits?

Savings accounts and term deposits also move in line with the cash rate, meaning 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. But at the end of the day, this will depend on individuals’ circumstances, such as their income and job security.

If, on the other hand, 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, you can bet they won’t hesitate to pass it onto savers.

Can interest rates go below zero?

While countries like Japan and Sweden have taken interest rates below zero, it’s unlikely that Australia will go down the same path. RBA Governor Philip Lowe has taken every available opportunity to dismiss negative interest rates as a possibility.

While low interest rates can help boost spending and investment, there are concerns that negative interest rates will impact consumer confidence, causing Australians to hold onto their money rather than pour it back into the economy.

The central bank boss has also pointed out that rates below zero could put a strain on banks’ profit margins, potentially stifling the flow of credit to households and businesses.

For more information about the cash rate and how it affects households’ finances, visit our home loan statistics page, where we provide a historical overview of the home loan market in Australia.

Home loan comparisons on Mozo - rates updated daily

Search promoted home loans below or do a full Mozo database search. Advertiser disclosure.
  • placeholder
    Mozo Experts Choice 2021
    Smart Booster Home Loan

    2 Year Discounted Variable Rate, Owner Occupier, Principal & Interest, <80% LVR

    interest rate
    comparison rate
    1.85% p.a.variable for 24 months and then 2.25% p.a. variable
    2.21% p.a.
    Go to site
    Details
  • placeholder
    UHomeLoan

    Owner Occupier, Principal & Interest

    interest rate
    comparison rate
    1.95% p.a.
    fixed 3 years
    2.27% p.a.
    Go to site
    Details
  • placeholder
    Mozo Experts Choice 2021
    Celebrate Variable Home Loan

    <60% LVR, Owner Occupier, Principal & Interest

    interest rate
    comparison rate
    1.99% p.a. variable
    1.99% p.a.
    Go to site
    Details
  • placeholder
    Variable Home Loan

    Owner Occupier, Principal & Interest

    interest rate
    comparison rate
    1.99% p.a. variable
    1.99% p.a.
    Go to site
    Details
  • placeholder
    Basic Home Loan

    Fixed, Owner Occupier, Principal & Interest, LVR<70%

    interest rate
    comparison rate
    2.09% p.a.
    fixed 3 years
    2.32% p.a.
    Go to site
    Details

* WARNING: This comparison rate applies only to the example or examples given. Different amounts and terms will result in different comparison rates. Costs such as redraw fees or early repayment fees, and cost savings such as fee waivers, are not included in the comparison rate but may influence the cost of the loan. The comparison rate displayed is for a secured loan with monthly principal and interest repayments for $150,000 over 25 years.

** Initial monthly repayment figures are estimates only, based on the advertised rate, loan amount and term entered. Rates, fees and charges and therefore the total cost of the loan may vary depending on your loan amount, loan term, and credit history. Actual repayments will depend on your individual circumstances and interest rate changes.

Mozo provides general product information. We don't consider your personal objectives, financial situation or needs and we aren't recommending any specific product to you. You should make your own decision after reading the PDS or offer documentation, or seeking independent advice.

While we pride ourselves on covering a wide range of products, we don't cover every product in the market. If you decide to apply for a product through our website, you will be dealing directly with the provider of that product and not with Mozo.