BREAKING NEWS: The Reserve Bank of Australia has cut the official cash rate by 0.25 percentage points to a record low of 0.5 per cent.
Firstly, a quick synopsis. We constantly read and hear about the RBA’s interest rate and how it will affect the economy, but how many of us know what it is?
The Reserve Bank of Australia is a body corporate entirely owned by the Commonwealth of Australia. It is Australia’s central bank and its main role is to maintain the stability of the country’s financial system, with the public face of its role made manifest through its role in setting the cash rate. The cash rate is announced after each RBA board meeting, which is usually once a month, apart from January.
Despite some common misconceptions, the RBA interest rate does not dictate the interest rates individual banks set for their loans (whether they are business loans, personal loans or home loans). Instead, the RBA interest rate is that which affects overnight loans in the money market.
How does this affect banks? Because they sometimes need to take out overnight loans to help fund their various transactions. Yes, banks sometimes run out of cash and that’s why they take out overnight loans, which have an RBA interest rate.
So, a low RBA interest rate (sometimes called a ‘cash rate’), in theory, drives further business by banks because they know that if they need to take out a loan to fund their own transactions they won’t have a large interest rate attached to it. If the cost of taking out a loan by a bank is low, then they are likely to take more risks through lending to more businesses and individuals and driving the circulation of money through the economy. Simple!
“The decrease in RBA interest rates since 2008 have certainly contributed to the surge in house prices, especially in Melbourne and Sydney,” says CEO of realestateVIEW.com.au, Enzo Raimondo. “This can be seen in some of the less obvious consequences of a low cash rate. For instance, lender confidence has allowed home owners to either borrow and spend more on their homes, driving up their value, or borrow on their increasing equity to in turn become investors with multiple properties.
“The risk of this sort of increase in lending activity is that those who are not in the strongest of financial positions enter into higher risk, if not untenable, financial contracts with their lenders.”
With a decreased cash rate comes increased confidence by the banks to lend money. The risk of this is that if they lend to those who have little money to spare, following their mortgage repayments, not only is there a risk of the loan arrangement collapsing from any unforeseen changes to either the lender or investor but that the investor has little cash flow to spend within the economy.
If you have been saving to get your foot on the property ladder, or to further invest, a decrease in the RBA cash rate may not be the best news, depending on where you are in your savings timeline. A decreased cash rate usually means a decrease in your savings account’s interest rate return. If you are nearing your savings goal, however, you may be in the perfect position to enjoy the benefits of decreased loan rates and the confidence of banks and lenders.
Existing mortgage holders may expect for any cuts in the interest rate to be passed on to them via their lenders decreasing mortgage rates. If this is the case, they can either reduce their mortgage repayment amount or keep their mortgage repayments as they were and enjoy significant savings in their interest costs. However, recent history has shown that banks will not always pass on these savings, but even increase mortgage rates in answer to new lending regulations as well as surging house prices.