On the first Tuesday of every month, the Reserve Bank of Australia (RBA) decides if the cash rate will increase, decrease or should remain the same. After sitting unchanged for almost three years, there have been three rate cuts this year, and it is now sitting at an historical low of 0.75%. Here's what that means for ordinary Australians.
— 10 News First (@10NewsFirst) October 1, 2019
Even if you're not into politics, the cash rate can actually affect how you live your life, so it’s a good thing to understand. With the long weekend around the corner, you're probably more worried about how the weather will turn out for your backyard barbie. So, we’ll keep it short.
What is the cash rate?
Put simply, the cash rate is the interest rate that banks charge on overnight loans, among other things.
This may seem like it has nothing to do with the everyday Australian, but the cash rate is used as a tool by the Reserve bank to influence economic activity as a whole.
What is an overnight loan?
Banks are always lending money between themselves, as they can never predict the exact number of transactions that will be made or how much cash they need.
Let's say that Westpac needed to borrow $2000 from the RBA, to meet larger than expected demands for cash from customers. They can borrow this money from the RBA overnight,and return it in the morning with interest.
If this happened today, with the cash rate now at an historical low of 0.75%, Westpac would need to pay only $15 in interest to the RBA.
Why is a low cash rate a good thing?
A lower cash rate encourages banks to lend more.
With a low interest rate, banks owe less interest on overnight loans, so there's less risk overall of running out of cash, and banks feel more secure in their lending.
How does the cash rate actually impact me though?
The impact of the cash rate changes can be seen in two main areas:
- Affects other interest rates in the economy
- Affects economic activity and inflation
Although the cash rate can only directly dictate the interest rates on overnight loans, it serves as a benchmark for interest rates across the board.
You could get a much cheaper home loan
With interest rates on home loans beginning with 2, it's hard to think that this RBA cash rate change will push the major bank's interest rates any lower.
However, it's important to look at the smaller lenders when the cash rate sits at an historical low.
It's unlikely the big banks will cut any further than they already have, but this might be the time to look at smaller, more agile lenders, who are able to pass on more of these rate cuts to the customer.
Athena, for example, passed on the full 0.25 basis points (bps) cut, and are now offering an Owner Occupier Principal and Interest home loans for just 2.84%.
Online lender, Homestar, will also pass on the third rate cut in full. Effective immediately for new enquiries and from 28 October 2019 for existing customers, these rate reductions will take some Owner Occupier Principal and Interest home loans to as low as 2.74%.
Your savings account won't be growing as fast
If you've spent years saving money in a high interest savings account, you could be left a little saddened by the rate cuts. Essentially, a rate cut means savings accounts accumulate a lower amount of interest, meaning less extra money you've made by doing nothing.
For those with a very large nest egg, specifically retirees who may rely on interest every month for additional income to the pensions, you will be missing out on the interest you once knew.
However, positive interest rates on savings accounts, no matter how small, beat negative interest rates hands down.
Overseas, wealthy depositors at Germany's Skatbank end up paying 0.4% for the privilege of having somewhere to store savings over €500,000. That might seem a little like a #firstworldproblem, but if you're into letting your money grow by doing nothing, it can become an issue.
Unless you have a degree in economics, this will all seem pretty complicated, but the key thing to understand is that the cash rate does affect you.
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