What is the RBA and why are they lowering interest rates?
You’ve probably heard some news about the RBA (Reserve Bank of Australia) and interest rates in the past few days and may have wondered to yourself, “why does this matter?”. To save you a few annoying Google searches here is a basic rundown of the RBA, interest rates and the role they both play in determining the direction of the Australian economy.
The Reserve Bank is unlike the commercial banks you deal with every day (such as CBA or NAB) and performs a very different function. The RBA is tasked with maintaining the stability of the financial system, the Australian dollar, employment markets and the broader economy. It also provides banking services to the Australian government allowing the country to take on debt to fund activities such as building infrastructure and funding social security.
The RBA is led by a board of economists that are appointed by the treasurer. These board members monitor a wide range of statistics including CPI growth, employment levels, wage growth and inflation and make monetary policy decisions based on this data in order to keep the economy healthy.
The main tool that the RBA have at their disposal for directing the economy is the overnight money market interest rate, or cash ratefor short. This is the rate of interest that the RBA charges commercial banks (CBA, Westpac etc) to borrow money. Commercial banks borrow money from the RBA so that they can provide home loans and other products to customers. This is the rate that the RBA has recently cut and the reason you have seen so much of the RBA in the news recently.
But why did they cut rates, and what does that even mean?
The cash rate is used to control the economy. When business is booming and the economy is strong, there is a great incentive to borrow money to continue growing and making more money. As growth speeds up in an economy the price of goods and services such as food and healthcare can increase, making the cost of living more expensive for the average person. This is referred to as “inflation”. In order to slow down this inflation, the RBA can raise the cash rate to make it more expensive to borrow money. Expensive borrowing leads businesses to stop investing in new projects or hiring new employees which causes the economy to slow down, undoing some of the inflation that was causing prices to rise.
The opposite occurs when the economy is slowing down and employment and wages growth figures are falling. The RBA can lower the cash rate to encourage businesses to borrow more money, hopefully stimulating growth.
This scenario is where we found ourselves this week. The RBA decided to lower the cash rate due to slower global trade growth and to stimulate employment and wages growth in Australia. It remains to be seen if the commercial banks will pass on this rate cut to home loans and other borrowers.
The RBA announcement can be found here if you’d like to read more into their decision:https://www.rba.gov.au/media-releases/2019/mr-19-15.html