Since May 2006 the cash rates have gone up by 1%. Its currently at 6.75%. The Reserve Bank Board meets on the first Tuesday of every month. In the meeting the Board makes decisions about the level of interest rates - the cash rate. Interest rate rises affect every household.

Every time there is rise in cash rate the banks and non-bank lenders increase the home loan rates and rates of all personal loans. In this post I am going to write about the basic reasons for a rate rise…The aim is to explain all in relatively simple terms…

Cash Rate target is the desired rate of interest on overnight loans between banks. So if the Reserve Bank increases Cash Rates then the banks we borrow from will increase the interest rates of the standard variable home loan rates. Its worth noting that the home loan rates are never the same as the cash rates. It’s usually at least one percentage more that cash rate - mainly because the banks add the expenses of lending (funding costs) to the home loan rates.

source: RBA

The Fundamentals: When the economy is booming, unemployment is usually very low. And also when the economy is doing well it means good rises in wages and salaries. The outcome of this is more disposable income and which leads to more spending. When we spend a lot, the spending has to be controlled. If the spending is not controlled prices will increase (rise in inflation). Hence to control spending (and in the process control price rise), Reserve Bank increases rates. When rates rise our disposable income reduces and hence we spend less. Goal achieved.

More Spending = Price Rises (increase in inflation) = Next Step Control Inflation = Done By Increase in Interest Rates = Less Spending = Reduce in Price Rise

But bear in mind that its not as simple as I have put it. Just because the spending is on the rise if the Reserve Bank goes ahead and increases rates it might affect the economy and the economy can face a down turn. Hence its a fine balance and Reserve Bank considers a number of factors and figures and analyses them with a fine tooth comb before making a decision.

On the other side of coin if the economy is on a downturn and our spending is low then the Reserve Bank considers a rate drop to boost the economy.

Factors Reserve Bank Considers:

• Inflation: This is simply the percentage increase of goods and services.
• Level Of Borrowing: This is the amount of money borrowed by people - mortgages, credit cards, personal loans etc. If the borrowing level is more that means they are in a way spending more.
• Retail Sales: If this figure is more then it again means that people are spending more.
• Low Unemployment: This means that most of us are employed and hence most of us have money to spend.
• Economy Level: Its not as simple as going through the figures for each of the above and making the decision. Whatever Reserve Bank does it has to do so that it does not have an adverse affect on the economy….
• Inflation:Since inflation is one of the things we constantly hear in the news I am going to elaborate a bit further on this topic: There are two types of inflation - headline inflation and underlying inflation. Headline inflation is subject to temporary fluctuations eg…This rose due to the price of bananas during cyclone Larry. Underlying inflation evens out these temporary fluctuations. Underlying inflation is what the Reserve Bank places importance on. The aim is to keep this between 2 and 3 percent comfort zone.

So that is the basics of why interest rates rise and fall…(without much jargon)

Related Posts:

• What Are Interest Rates Doing?
  The official interest rates is at a 12 year high at 7.25 per cent. The home loan rates is between 9 and 10 per...
• Current Mortgage Interest Rates
  The official interest rate is currently at a 12 year high of 7.25 per cent. Usually whenever RBA rises official interest rates, banks follow...
• Will Australia Face Recession?
  For the past one year, there has been plenty of coverage in the media about the recession in America, doom of its housing market,...
• Interest Only Home Loans
  Lately, the number of people taking out interest only home loans has been on the rise. With the normal loans you are paying off...

Topics: Financial Topics |

Comments

Name (required)

Mail (will not be published) (required)

Website

« Credit Card Terminology Explained | Home | Medicare Levy Surcharge »