What is the cash rate and why does it change?

There’s been a lot of hype in the media about the cash rate dropping to historical lows but what does the actually mean? And how does it impact the property market?

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Every month except January, the RBA board meets to decide on the most appropriate monetary policy for Australia’s economic environment. This policy involves setting the cash rate, which is the interest rate banks charge each other on overnight loans.

Banks lend money to other banks each day to manage daily cash needs. Given that these are short term loans, they are known as “overnight” funds and the interest rate charged is an overnight rate.

The RBA is a body corporate wholly owned by the Commonwealth of Australia, and work towards the best interest of the Australian economy.

In the last 5 months from June to October 2019, we have had 3 cash rate drops of 0.25 basis points each.

The cash rate originally started at 1.5% which it hadn’t moved from since August 2016 and is now down to 0.75%.

So for 34 months, we didn’t see any movement in the cash rate, and in the last 5 months, we have seen 3 rate cuts.

These cash rate cuts are passed onto the banks who choose to pass them onto their clients or not. If they choose to pass them onto their customers, they apply the decreased rate to their loan and savings account packages.

Basically, reducing the amount of interest you have to pay on your loans but also reducing the amount you earn from holding money in a savings account.

This encourages the population to spend more money, rather than store it as savings, additionally, it seduces the population to borrow more money at a lower interest rate to buy more expensive assets such as cars or property.

This ultimately recycles more money back into the economy, this is what we call “stimulating the economy” encouraging spending to grow the economy.

As with any business, the banks have overhead costs with paying staff and having offices ect, so the interest rate they give you doesn’t match the cash rate set by the RBA exactly, banks put a margin on top typically around 2%.

Lower rates typically mean an increase in housing prices, there has been speculation that borrowing capacities have increased by 15% since the cash rate was at 1.5% and borrowing criteria has loosened from APRA.

This means that banks will now allow you to borrow 15% more than you could have previously, giving home buyers more money up their sleeves to spend.

Generally, us Australians love the confidence boost of borrowing as much as we possibly can, buying the biggest house we can afford, and showing it off at the next BBQ.

Which then encourages the 3 people we talked to at the BBQ to do exactly the same thing, borrow as much as they can, overpay for a property and ultimately creates an upward spiral of prices and demand for property.

In addition to these owner-occupiers distilled with confidence to go out and buy a new home, investors are also in the same boat, they can borrow more money and together they cause a stampede at open homes, and a bidding frenzy at Auctions, causing housing prices to rise.

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