How Are Interest Rates Set In Australia?
Interest rates have a significant effect on homebuyers, investors and the Australian economy as a whole and the official rate is set by the Reserve Bank of Australia (RBA). The Reserve Bank sets the target ‘cash rate’ (the market interest rate on overnight funds) and uses this as the monetary policy instrument, influencing the cash rate through its financial market activities.
Decisions on the cash rate target are made by the Reserve Bank Board and are explained in a media release at 2.30 pm after every Board meeting. However, the banks and other financial institutions aren’t required to set their rates at the official level. In the past, it was a different story.
So what is the role of the RBA today in setting interest rates?
Let’s begin with some history:
The Way Interest Rates Used to Be Set
About 40 years ago, interest rates in Australia were set by the government, and the RBA lent money to the banks who then lent money to consumers.
The RBA lent the money to the banks at a variable interest rate and the banks passed that rate on with a mark-up to customers wanting loans.
The mark-up was to allow the banks to make money during the lending process. However, with governments and public servants controlling interest rates, it meant they could use it as political leverage.
In other words, if the government in power needed more money they could raise interest rates because the interest collected by the RBA was revenue, which was not a very economically healthy situation.
In the 1990s Australia went through a recession and the Prime Minister at the time, Paul Keating, decided that the RBA should become independent.
He set up an independent board to govern the RBA with the following goals:
- To help maintain levels of employment
- To stabilise the Australian currency
- To ensure the welfare and economic prosperity of Australians (1)
The Way Interest Rates Are Now Set
To ensure its targets are met, the ideal inflation rate is deemed to be 2-3 per cent a year on average. The RBA board can influence the rate of inflation by raising or lowering official interest rates in the following ways:
- Once a month the RBA checks the price of the key indicators which is everything from the price of bread to the cost of fuel, to the impact on the economy of climate change.
- It notes price trends to keep track of inflation.
- If inflation looks like rising significantly, the RBA will raise official interest rates.
- The banks then increase their interest rates which results in homeowners and property investors spending less money, and this reduces the pressures on inflation.
- If inflation drops significantly, the RBA will cut interest rates.
When the RBA cuts the official interest rate, the banks at varying speeds will lower their rates. However, the bank’s rates are most often quite a bit higher than the official interest rate.
Even so, people paying off their mortgages will have more money at their disposal so they will spend more and inflation will level out in time. Therefore, the RBA has the power to stimulate or dampen the economy as necessary.
What is the RBA Interest Rate in 2019?
As of March 2019, Australia’s interest rates are sitting at 1.5 per cent, which is the lowest this country has ever experienced and they will remain there, or even go lower, for quite some time.
The low rate is a good chance for savvy property investors to fix their rate for at least five years. They can hold onto their properties when rents rise and then reassess their position.
As the country’s central bank, the RBA has a broad reach when it comes to managing the economy.
The deputy governor of the RBA, Guy Debelle, has given a speech about the economic impact of climate change, warning that it poses risks to Australia’s financial stability. M Debelle noted in his speech at a forum hosted by the Centre for Policy Development that warming needed to be thought of by policymakers and business as a trend and not a cyclical event(2).
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