Understanding the Cash Rate vs. Interest Rates
Confused about the difference between the RBA cash rate and interest rates? Discover how they impact the economy and your hip pocket.
Unless you’ve been hiding under a rock in recent years, you’ll have heard of the cash rate. You’ve probably also seen lots of news of interest rates, which are more familiar to the typical consumer.
It’s easy to confuse talk of the cash rate with discussions on interest rates, and vice versa, but the two differ notably.
The cash rate is the major driver of interest rates and interest rates impact the finances of Aussies, particularly those with home loans.
Let’s dive deeper.
What is the cash rate?
The cash rate is a key pillar in the Australian economy. Cash rate is the interest rate which banks pay to borrow funds from other banks in the money market on an overnight basis.
Banks must end each day with enough cash to meet liquidity ratios, meaning they can’t lend out every dollar deposited by consumers. Hence they often need to borrow money for the night to meet these requirements. One bank might ask another if it has spare cash. If it does, the borrowing bank pays interest at the cash rate.
The cash rate is the Reserve Bank of Australia’s operational target for the implementation of monetary policy. It is also an important financial benchmark in the Australian financial markets.
The Reserve Bank of Australia is the administrator of the cash rate. The cash rate is calculated as the weighted average interest rate on overnight unsecured loans between banks settled in the Reserve Bank Information and Transfer System (RITS).
The Cash Rate is also known by the acronym AONIA – AUD Overnight Index Average in financial markets
What are interest rates?
Interest is also what banks charge to borrowers and give to depositors. If you have a savings account, chances are you’ve been given interest at some point. If you’ve had a loan, you’ve probably had to pay interest.
An interest rate is how a bank or lender communicates how much interest it will be charging to borrowers or providing to depositors each year. It’s expressed as a percentage of the loan balance.
So, if you have a $100,000 home loan at a 6% per annum (p.a.) interest rate, you might expect to pay $6,000 of interest a year (6% of $100,000 is $6,000).
What’s the relationship between the RBA cash rate and interest rates?
How are the cash rate and interest rates related? Well, the higher the cash rate, the higher the interest rates lenders tend to charge borrowers.
That’s because, the higher the cash rate, the higher the cost of doing business is for banks, and they’ll typically try to recoup their extra costs by increasing interest rates on home loans and other debt products.
Lenders generally reach out to home loan borrowers in the days and weeks following a cash rate movement to alert them that their rates are about to change.
For example, after a cash rate increase, lenders typically inform variable rate home loan borrowers that their rates will rise. Of course, fixed rate home loan borrowers are spared from interest rate changes during their fixed rate period.
Though, not all lenders will adjust interest rates after every cash rate movement. The response to changes in the cash rate can vary among lenders due to several factors, including their funding costs, the level of competition between banks, and their overall business strategy.
Some lenders might choose to absorb the cost of cash rate increases in an effort to maintain customer loyalty or market share, for instance, while others might pass on the full cost straight away.
Why might the RBA change the cash rate?
The cash rate has been cut, sliced, diced, and hiked amid the pandemic and the following cost of living crisis.
Each change in the cash rate is deliberated carefully by the Reserve Bank of Australia (RBA) board.
The RBA board uses the cash rate to stabilise the Australian economy. And perhaps the most destabilising force present in the economy is inflation.
Inflation drives the cost of goods and services up and, therefore, the value of each dollar down (as inflation means that each dollar gets you fewer goods or services). We need a certain level of inflation in the economy to stimulate economic growth. But too much inflation can be disastrous.
The RBA board aims to keep inflation in the realms of 2% to 3% a year. If inflation is too high, the board might increase the cash rate – as we’ve seen since mid-2022 – and if inflation is too low, it may drop the cash rate – as it did in 2020 and 2021.
So, what can influence inflation? The answer is demand and supply.
How supply and demand imbalances impact inflation
Too much demand and not enough supply leads to increased inflation, while too little demand and too much supply can lead to lower inflation.
Let’s use a fruit stall as an example to illustrate how an imbalance of demand and supply can impact inflation.
Let’s imagine a fruit stall that can sell 100 apples a day, and has 120 customers willing to buy apples each day. The stall’s owner might decide to increase the price of each apple to A) discourage some customers from buying and B) increase their income.
If, however, the fruit stall only saw 80 customers a day, its owner might choose to reduce how much it charges per apple to encourage more people to purchase.
How does the cash rate influence inflation?
The cash rate influences inflation by essentially making it harder to access money.
When borrowing money becomes more expensive (like after a cash rate hike), people and businesses are less likely to take out loans. They may also cut back on spending so they can keep up with loan repayments.
Take a fruit stall, for example. After a rate hike, fewer people might buy apples because they’re trying to save money. So, the stall owner wouldn’t have a reason to raise prices—maybe they’d even lower them.
But if interest rates go down (a rate cut), people have more money to spend. More customers might come to the stall to buy apples, and with higher demand, the stall owner might decide to raise prices.
Why banks and lenders change interest rates outside of cash rate moves
Banks might change interest rates independently of cash rate moves to attract customers, manage profitability, or respond to market conditions.
For example, they may raise home loan rates to improve margins or offer a higher savings rates to attract depositors.
Ultimately, banks are businesses and they need to make sure they stay profitable.
Whatever the reason, banks and lenders don’t need to wait until the cash rate changes to make changes to their interest rates on offer. Though, they do typically need to give customers some notice.
RBA cash rate vs interest rates
| RBA cash rate | Typical bank interest rates | |
| Definition | The rate at which banks lend to each other overnight. | The rate charged by banks on loans and paid on deposits. |
| Set by | Reserve Bank of Australia (RBA) | Individual banks and financial institutions |
| Purpose | To influence economic activity, inflation, and employment. | To provide profit for banks on loans and savings accounts. |
| Frequency of changes | Typically reviewed every six weeks | Can change anytime based on market conditions, competition, and cost of funds. |
| Impact of rate change | Directly influences overall economic conditions and monetary policy. | Affects monthly repayments for loans and returns on savings. |
The Bottom Line
Understanding the difference between the RBA cash rate and bank interest rates can help you make more informed financial decisions. While the cash rate sets the tone for broader economic conditions, the interest rates you pay on loans or earn on savings are influenced by a mix of this and other factors like competition and lender strategy.
Keeping an eye on both can give you a clearer picture of what’s happening in the economy—and what it might mean for your mortgage, savings, or investment plans. So next time the RBA announces a change to the cash rate, you’ll know exactly why it matters and what to watch out for.
Need Help Navigating Interest Rates?
Whether you’re a first-time buyer, refinancing your home, or just trying to understand what a cash rate change means for your loan, we’re here to help.
Connect with us today to get personalised guidance and expert support from a broker who understands how the cash rate impacts your bottom line.
Disclaimer: This blog offers general information on mortgages and finance for informational purposes only. It is not a substitute for personalized advice from a qualified mortgage professional or financial advisor. Use your discretion and seek professional guidance based on your individual circumstances.
