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 has many uses. It's a key pillar in the Australian economy, after all.

One of its important functions is being the rate that banks charge each other to borrow money overnight.

Banks must end each day with enough cash to meet liquidity ratios, meaning they can't lend out every dollar deposited by consumers. Often, they need to borrow money for the night to meet these requirements.

That's where the cash rate, sometimes called the 'overnight money market interest rate', comes into play.

One bank might ask another if it has spare cash. If it does, the borrowing bank pays interest at the cash rate.

## 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, which meets every six weeks.

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.

The chart below shows the relationship between the Australian Bureau of Statistic's annualised inflation rate (measured monthly) and the cash rate.

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.

If borrowing money becomes more expensive, people and companies will presumably be less likely to take on debt and might be forced to tighten their purse strings.

In the case of the fruit stand, it might find its customers dwindle after a cash rate hike, as those who might have otherwise bought apples look to reduce their spending and funnel more money into managing debt repayments. The stall owner would therefore have little reason to increase prices.

On the other hand, the stall might find lots more people want apples after a cash rate cut, as they have more money to spend. The stall owner might increase prices as a result.

## 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.

### Check out these low-rate home loans available now

For those in the market for a home loan, or perhaps considering refinancing, here are some of the most competitive mortgage interest rates out there right now:

Update resultsUpdate
LenderHome LoanInterest Rate Comparison Rate* Monthly Repayment Repayment type Rate Type Offset Redraw Ongoing Fees Upfront Fees LVR Lump Sum Repayment Additional Repayments Split Loan Option TagsFeaturesLinkCompare
6.04% p.a.
6.06% p.a.
\$2,408
Principal & Interest
Variable
\$0
\$530
90%
Featured 4.5 STAR CUSTOMER RATINGS
• Low rates for purchase and refinancing
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• No fees, unlimited redraws, 0.10% offset
5.99% p.a.
5.90% p.a.
\$2,396
Principal & Interest
Variable
\$0
\$0
80%
• A low-rate variable home loan from a 100% online lender. Backed by the Commonwealth Bank.
6.14% p.a.
6.39% p.a.
\$2,434
Principal & Interest
Variable
\$248
\$350
70%
6.14% p.a.
6.19% p.a.
\$2,434
Principal & Interest
Variable
\$0
\$595
70%
6.14% p.a.
6.17% p.a.
\$2,434
Principal & Interest
Variable
\$0
\$799
80%
6.09% p.a.
6.11% p.a.
\$2,421
Principal & Interest
Variable
\$0
\$250
60%
Featured
• No annual fees - None!
• Get fast pre-approval
• Unlimited additional repayments free of charge
• Redraw freely - Access your additional payments when you need them
• Home loan specialists available today
Important Information and Comparison Rate Warning

Base criteria of: a \$400,000 loan amount, variable, fixed, principal and interest (P&I) home loans with an LVR (loan-to-value) ratio of at least 80%. However, the ‘Compare Home Loans’ table allows for calculations to be made on variables as selected and input by the user. Some products will be marked as promoted, featured or sponsored and may appear prominently in the tables regardless of their attributes. All products will list the LVR with the product and rate which are clearly published on the product provider’s website. Monthly repayments, once the base criteria are altered by the user, will be based on the selected products’ advertised rates and determined by the loan amount, repayment type, loan term and LVR as input by the user/you. *The Comparison rate is based on a \$150,000 loan over 25 years. Warning: this comparison rate is true only for this example and may not include all fees and charges. Different terms, fees or other loan amounts might result in a different comparison rate. Rates correct as of .

Important Information and Comparison Rate Warning

## 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.

Image by Melissa Walker Horn on Unsplash