The Cash rate is the interest rate which banks pay to borrow funds from other banks in the money market on an overnight basis. The Reserve Bank of Australia (RBA) is the administrator of the cash rate and the RBA board meets to decide the most appropriate monetary policy for Australia economic environment which currently sits at 1.5%.
Banks lend money to other banks each day to manage daily cash needs. Given that these are loans for the shortest term, they are known as “overnight” funds and the interest rate charged is an overnight rate.
The cash rate influences other interest rates in the economy, affecting the behaviour of borrowers and lenders, economic activity and ultimately the rate of inflation. The cash rate can affect the interest rate on your mortgage, it can affect how much interest your savings might earn and on a broader scale, it's tied up with inflation, jobs and the general health of the economy.
When the RBA raises the cash rate, generally it is because they want to put the brakes on demand growth and the rate of inflation. Higher interest rates tend to act as a restraint on lending growth, which has a negative impact on demand and inflation.
A higher cash rate can have a flow-on effect that lifts interest rates on credit card, loan and mortgage repayments, leaving consumers with less available income to save or spend.
Knowing that if the cash rates rises, those debt repayments can go up, too, might discourage people who don't already have a loan or a mortgage from entering the market.
If the cash rate falls, the RBA is trying to boost economic activity and inflation by encouraging consumer spending and business investment – lower interest rates encourage businesses and households to borrow rather than save which lifts economic activity.
For property owners with a mortgage, lower interest rates could reduce their repayments and result in more disposable income. The lower cost of borrowing money might also encourage people to take out loans to purchase properties.
When the RBA increases the cash rate, interest rates on deposits usually rise as well. This can encourage people to save rather than spend. Conversely, when interest rates decrease, it becomes less appealing to save money. From a cash rate decision perspective, fluctuations in the exchange rate are important because they affect the prices of imports and exports. If the value of the Australian dollar falls against other currencies, then imports become more expensive in Australian dollar terms and exports become cheaper. This will generally have a positive impact in terms of economic activity, but can also lead to inflation, which is when prices rise.
Given the cash rate decision is made by the RBA in the context of trying to keep inflation within a certain band, currently a target range of 2% to 3%, to support healthy growth in the economy, Australia's exchange rate is a very important factor. When interest rates increase in a particular country, foreign investors may be more attracted to invest there. This is because the potential returns available on assets that earn interest have increased.