The interest rate set by the RBA won’t be the one you pay on a loan or mortgage, but is the rate the RBA will charge banks such as the Commonwealth or NAB to borrow money from it. This is how it works.

All banks in Australia have to balance their books at the end of each day. But because these are large and geographically widespread financial institutions it’s physically impossible for them to get every scrap of cash back into their vaults each night, so they have to borrow money to make good any shortfall and they do this by going to the RBA.

The interest rate banks borrow at is called the ‘cash rate’ and it’s this, with ‘a bit on top’ to cover their costs and provide them with a profit, that the banks then charge on to us. This rate is known as the ‘bank rate’ and it’s up to the banks themselves to decide what this should be.

They will make their decision based on a number of things, such as what their competitors are charging, what they think their customers will accept, what level of risk they want to expose themselves to, and whether they want to bring in new business.

When the RBA changes its interest rate, the banks usually change the rate they charge us by a similar amount. If the RBA puts up its rates you end up having to spend more to repay any loans you have, and pay a higher rate of interest on any new loans. Both take more money out of your pocket, meaning you’ll have less to spend on other things. This reduces demand for products and services, which is why an increase in interest rates is used by the RBA to fight inflation.

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