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RBA and the Interest Rate

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RBA and the Interest Rate

The Reserve Bank of Australia decided to hold the current interest rate at 2% last Tuesday.

What were the influences on the RBA’s decision?

Multiple aspects determined the RBA’s action, which were detailed in their press release and summarised as follows:

The World Economy:

The RBA referenced indicators that showed the world economy is continuing to grow at a much slower rate than economists predicted. China’s growth rate, while still positive, has continued to slow somewhat.

Australia:

Because Australia is considered only a “small” economy, we are very much affected by outside influences. Commodities (materials such as iron ore, oil, wheat) have suffered falling prices for the past 5 years, and exports of these materials play a major part in our economic growth.

Outlook:

Many experts that the RBA consults are uncertain about how the world economy will behave in the short and long-term, as very few countries are raising their interest rates. In some instances countries have gone into negative interest rate territory. (Switzerland  and Sweden are current examples.)

Summary:

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The RBA considered the above information and determined that Australia’s economy is now readjusting to itself, as investments in mining have subdued significantly (Consider; at its peak in 2008, mining was attributed to just under 8% of the total output of the Australian economy. It is now closer to 4%).

The RBA considered that a rise in interest rates would “complicate the adjustment under way in the economy”.

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Quick Facts:

  • The RBA serves as the “Banker to the banks and the Australian Government”
  • Banks hold reserves of cash in the RBA’s “Exchange Settlement Accounts”. The RBA sets the policies which govern how this money is stored (how much or how little a bank is allowed to hold onto) and the interest rate at which it will loan money to the banks. These policies control the supply of money, which has an effect on interest rates.
  • The Reserve Bank Board meets monthly regarding the many policies they set. One of the most common policies they change is the “Cash Rate”. (Keep in mind that the RBA does not actually “set” the rate, but sets a target rate, and manipulates what is called the “Money Base”. It does this by buying and selling government bonds to banks, which affects how much money they have available for lending to the public, businesses and other banks). 

Questions:

Why not have the lowest interest rate all the time?

The interest rate acts as a “break” on the economy. The exact reasons are too complex for this article, but put simply, if the economy grows too fast, inflation will rise and cause issues for everyday Australians (prices rise faster than wages, generally speaking).

The RBA sets the interest rate low in an attempt to stimulate the economy.

An interest rate of 2% is considered low – How low is it?

The closest the “cash rate” has ever been to 2% was during the 2008/2009 GFC, when it hovered around the 3% mark. Considering that the rate was 3% in the middle of a worldwide financial crisis, this could be considered a dire economic indicator. However, Australia’s economy grew by 1.75% even during the worst of the crisis. Currently, the RBA is trying to kick-start the economy back into action to pre-GFC levels, and reduce the level of unemployment.

Picture1Source: www.rba.gov.au