What is the cash rate? And how is it different to interest rates? | News Glossary

Summary

The Reserve Bank of Australia controls the economy by managing the cash rate, which influences how much interest banks charge each other for overnight loans. Lower cash rates encourage banks to lower their own rates, making loans cheaper and stimulating the economy, while higher rates make loans more expensive, cooling it down. This tool helps maintain a healthy economic balance.

Takeaways

• 🏦 The Reserve Bank of Australia (RBA) is the central bank that regulates financial systems and controls the cost of interbank lending.
• 💰 Commercial banks need to maintain liquidity to meet customer withdrawals, and may borrow from other banks overnight at the 'cash rate'.
• 📉 The RBA influences the economy by setting a target cash rate, which affects the cost of borrowing between banks.
• ⚖️ Changes in the cash rate target by the RBA do not mandate banks to change their customer interest rates, but often influence them to stay competitive.
• 📈 When the economy is sluggish, the RBA may lower the cash rate target to encourage banks to lower interest rates, stimulating spending and investment.
• 📉 Conversely, if the economy is overheating with rapid inflation, the RBA may raise the cash rate target to cool down spending by increasing the cost of loans.
• 🏠 Lower cash rates make home loans and business loans cheaper, potentially encouraging more borrowing and investment.
• 💸 Higher cash rates make loans more expensive and savings accounts more attractive, potentially leading to increased savings and reduced spending.
• 🌐 While the cash rate is significant, Australian banks also borrow from international markets, which can also influence their lending rates.
• 🔄 The cash rate is a tool used by the RBA to indirectly influence consumer and investor behavior to maintain a healthy economy.
• 🤔 The script suggests that the cash rate is a subtle way for the central bank to guide economic activity, rather than a direct control mechanism.

Q & A

What is the Cash Rate?

The Cash Rate, also known as the Official Cash Rate, is the interest rate at which banks lend money to each other overnight. It is controlled by the Reserve Bank of Australia (RBA), which uses it as a tool to influence the economy.

What is the role of the Reserve Bank of Australia (RBA) in managing the Cash Rate?

The RBA is Australia's central bank and financial regulator. It sets a target for the Cash Rate and influences it to control the economy by making money more or less expensive to borrow.

How does the Cash Rate affect commercial banks?

The Cash Rate determines how much interest banks charge each other for overnight loans. If a bank like Westpac is short on cash, it might borrow from another bank like ANZ at the Cash Rate, affecting their profitability and liquidity.

Why do banks need to maintain a certain level of liquid cash?

Banks need to maintain liquid cash to ensure they can meet the demands of their customers who might withdraw money. This is crucial for maintaining their financial stability and trustworthiness.

How does the Cash Rate influence the interest rates on home loans and business loans?

While banks are not obligated to change their rates based on the Cash Rate, a lower Cash Rate makes money cheaper to move around, which can encourage banks to lower their rates on loans. Conversely, a higher Cash Rate can lead to higher loan rates.

What happens when the economy is slow and the RBA lowers the Cash Rate?

Lowering the Cash Rate makes loans cheaper, encouraging people to borrow more for investments like buying a house or starting a business. This can stimulate the economy by increasing spending and investment.

What is the impact of a high Cash Rate on the economy?

A high Cash Rate makes loans more expensive, which can deter borrowing and investment. This can lead to people saving more and spending less, potentially cooling down an overheated economy.

How does the Cash Rate affect savings accounts?

When the Cash Rate is low, savings accounts typically earn less interest. Conversely, when the Cash Rate is high, savings accounts can earn more interest, incentivizing people to save rather than spend.

What is the purpose of the RBA adjusting the Cash Rate?

The RBA adjusts the Cash Rate to control inflation and economic growth. Lowering the rate can stimulate the economy by making borrowing cheaper, while raising the rate can slow down an overheated economy by making borrowing more expensive.

How does the Cash Rate compare to other factors that influence banks' borrowing costs?

While the Cash Rate is a significant factor, banks also borrow from international markets. The Cash Rate sets the tone for the overall cost of borrowing, but other market conditions and global economic factors also play a role.