The RBA and Interest Rates

When considering a new home loan or changes to your existing mortgage one of the first considerations is the interest rates on offer. But what about the future direction of interest rates? For that we need to learn about an organisation called….

The Reserve Bank of Australia (RBA) is the Central Bank 1 that controls the cash rate 2, which in part controls the interest rate charged to consumers by lending institutions for credit products including mortgages and home loans.

So, why do they do that you ask! The RBA, under charter from the Government, has the goals of maintaining a stable Australian currency, maintenance of full time employment and economic prosperity for Australians.

The RBA uses monetary policy 3 to achieve it’s various targets one being inflation – as per the RBA website ‘Controlling inflation preserves the value of money. In the long run, this is the principal way in which monetary policy can help to form a sound basis for long-term growth in the economy.

A little history of the RBA explains more:

In 1945 Central Banking started to emerge in Australia and was originally a role of the Commonwealth Bank of Australia when the Chifley government passed the Commonwealth Bank Bill and the Reserve Bank Bill.

At that point monetary policy was still a role of the government and in 1959 with the Reserve Bank Act monetary policy started to separate from politics and come under the guidance of the RBA which was also separated from the Commonwealth Bank.

In the 1980’s the RBA came to prominence with financial deregulation initiated by the Fraser government and furthered by the Hawke/Keating government with the floating of the dollar. The RBA came further to the fore in the boom and bust period of the Hawke/Keating era with a push for putting inflation first in terms of breaking high inflation rates via monetary policy. An official inflation target was adopted in 1993.

Until 1996 the independence of the RBA and relations between it and the government had seen turbulent times until the Treasurer, Peter Costello of the incoming Howard government, introduced the ‘Statement on the Conduct of Monetary Policy‘. The statement endorsed the banks inflation target and formally endorsed the policy independence of the RBA.

The Board of the Reserve Bank meets on the first Tuesday of the month except in January to discuss detailed accounts of domestic and international financial markets and economies. Decisions made on interest rates by the Reserve Bank Board are released the following day.

Update: As of the 5/12/2007 the RBA now releases the outcome of their monthly meeting on the same day at 2.30pm. For the first time the RBA is also releasing the minutes of the monthly meeting which are released two weeks following the meeting.

Once the RBA Board has made a decision on the whether to lower, hold or raise the cash rate this will then be reflected in it’s open market operations which is the buying and selling of securities in the nations bond markets.

Chart: Interest Rates and Inflation in Australia:
interest rates vs inflation chart australia

So back to our home loan, how do we know where interest rates are heading, and how much should we allow for changes in rates?

For that we can look to the monthly statement on monetary policy issued by the RBA, along with taking in a wide range of opinion from various economists, to help provide a guide as to future rate expectations. As a general rule, you should have a sufficient buffer to allow for a number of interest rate rises which generally occur, as history would indicate, in .25% increments.

This is a simple overview of the RBA and it’s operations, more information and monthly statements on monetary policy visit: The Reserve Bank of Australia.

1. Central Banks are an interface between the economy and politics with the primary role of conducting monetary policy, in most cases by regulating the supply or price of money in the economy. An “independent central bank” is one which operates under rules designed to prevent political interference – examples include the US Federal Reserve, the Bank of England, the Bank of Japan, the Bank of Canada, the European Central Bank and the Reserve Bank of Australia.

2. Cash Rate: the rate charged on overnight loans between banks and financial intermediaries.

3. Monetary Policy: The management of the price and availability of funding for the economy’s expenditure.

Discuss