The team at Insight Wealth & Accounting advice keep a keen eye on the Reserve Bank’s interest rate announcements. This enables us to consider the state of the economy and predict what lenders will do in regard to credit interest charges. This week, the Reserve Bank again left interest rates unchanged at the record low cash-rate of 2.5%. This sounds like good news, certainly for those paying a mortgage or any other credit based debt (but perhaps not so good for those in retirement who have chosen to live off the interest they earn on bank deposits), it means that repayments remain stable this is because the decision to change the cash rate influences, to varying degrees, other interest rates in the economy including the rate that banks set on the money they lend.
What else does the cash-rate influence?
Why does the Reserve Bank look closely at the cash-rate in determining whether to lift or reduce it?
The principal medium-term objective of monetary policy is to control inflation. The Reserve Bank Board sets interest rates with the intention of stabilising the currency, maintaining full employment and economic prosperity. Controlling inflation also preserves the value of money over time. To achieve these objectives the RBA focuses on a target for consumer price inflation, of 2 to 3 per cent per annum.
If inflation is on the increase, the Reserve Bank of Australia may increase interest rates with the view to slowing growth and keeping inflation in check. The impact of increasing rates normally forces consumers and businesses to borrow less and save more, which slows down economic activity. In essence, loans become more expensive while holding more cash becomes more attractive.
On the other hand, to simulate the economy, interest rates may be decreased to encourage consumers and businesses to borrow which helps the economy to grow through a boost to retail and capital spending.
Why is the cash-rate and it’s movement different from the interest rate charged by banks?
Because of the way that Australian banks and financial institutions have tended to match the RBA’s rate movements in the past, most of us have come to expect that a reduction in the cash rate announced by the RBA will flow through to our personal mortgages. However, since the GFC banks have started to make changes outside of the RBA movements sometimes electing not to pass on the full reduction.
The difference between the interest rate set by the RBA and that set by the banks is influenced by the cost to the bank to borrow the money themselves to then lend on as they don’t typically have sufficient funds to cover their loans. There is also an allowance for administration costs, risks associated with lending as well as a margin in order to be profitable.
How can you take advantage of interest rate movements?
While you may have little influence over what rates a bank charges for its lending, you do have the option of considering what type of interest arrangement suits you best, given your personal circumstances as well as your view on economic outlook.
At Insight Wealth & Accounting Advice, we can help you consider which type of loan is right by taking into consideration not only the current interest rate but also the impact future fluctuations to interest rates may have on your ability to make repayments. This can assist you make the right decisions in the type of investment loan is right for your current circumstances and the current state of the economy and credit market. Give us a call on (02) 4941 1888 or contact us via our website.