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How interest rates are determined

Interest rates are a constant source of discussion and every month when the Reserve Bank meets there is speculation as to whether or not they will go up or down. Economists give their many reasons for and against a rate rise or decrease but in actuality there are only a few determining features when the decision is made. On the first Tuesday of each month (except January), the Board of the Reserve Bank meets to determine the appropriate stance of monetary policy in Australia and discuss the following economic factors:

  • Inflation is the main point of concern when determining interest rates. Inflation is the increase in the prices of goods and services. Inflation rose by 1.7% in the last quarter and is influenced by international events. It is a good bet that inflation is seen to be growing faster than the economy can handle then interest rates will be raised to decrease consumer spending and thus maintain stability in the economy.
  • The unemployment rate is also a determining factor. Unemployment figures are also released monthly and gauge the percentage of the workforce that is employed against those who are unemployed. The higher the unemployment rate the lower consumer confidence and spending which may to lead to a rate cut to boost consumer confidence and thus company spending and hiring. 
  • CPI (or the Consumer Price Index) determines whether or not a normal household is spending more or less on a day to day basis within a monthly period. Rises in petrol prices, food and general household goods determine this monthly figure. If there is a significant CPI increase across a month then it means that the economy is strong and the RBA may raise the official interest rate.
  • Lastly the RBA will look at retail sales. This is fairly self-explanatory in that when retailers report their monthly sales figures they will either record a slowing in retail sales, no change, or an increase in consumer spending. An increase means a growing economy which could lead the RBA to raise interest rates. 

The afore mentioned factors influence the RBA’s decision to decrease, leave or raise interest rates but how does this affect us? Changes in interest rates affect people with home loans, car loans, credit cards and other products offered by lenders.

Once the official cash rate is determined by the RBA then banks put their own percentage charge on which becomes the interest rate YOU pay. The official cash rate is the interest rate the RBA is charging banks to loan money from them. 

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