Inflation is a rise in prices which coincides with a fall in the purchasing power of money. Essentially, when prices rise, your money will buy you less. In Australia, the target inflation rate is 2-3% p.a., meaning an annual rise in prices within that range is expected. One common means to measure inflation is the Consumer Price Index (CPI). This is determined by calculating the total price of a basket of goods and services and comparing quarter on quarter to see if prices have risen or fallen. The items in the basket of goods and services reflect typical household expenditure and cover items such as groceries, housing costs, transport, education and there are some categories for discretionary expenditure such as recreation.
How is inflation monitored?
The policies and decisions of the Reserve Bank of Australia (RBA) aim to contribute to Australia’s economic stability. The RBA is responsible for monitoring inflation to ensure it stays within the 2-3% range. Monetary policy, specifically the cash rate is one means to which inflation is kept in check as it can influence the amount people have to spend, and therefore curb or stimulate spending which affects inflation.
What is the cash rate?
The Cash rate is the market interest rate charged on overnight unsecured loans amongst financial institutions. The cash rate is used as a guide amongst financial institutions on the interest rate charged to secure bank funding for deposits and wholesale debts.
Inflation and the cash rate
Historically, when inflation is high, the cash rate is raised to curb spending. If money is more expensive to borrow, consumers must contribute more towards increased loan payments, meaning less money leftover which results in a decrease in spending. If the economy is slow, the cash rate may fall to make borrowing money cheaper to stimulate economic activity and increase spending.
The RBA meet on the first Tuesday of each month, 11 times a year (excluding January) to review the cash rate. After the meeting, an announcement is made on the status of the cash rate. Cash rate changes can impact the cost of funds to financial institutions which they obtain to fund loans to their customers. Financial institutions pass on interest rate increases or decreases on loan and term deposit products to their existing or new customers at their own discretion.
What is interest?
Interest is an amount of money paid by a financial institution such as a bank or credit union to customers that have money in a savings or transaction account or charged by the institution to customers who have borrowed money from the bank through products like a car loan, credit card or home loan.
What is an interest rate?
The interest rate determines how much is paid or charged by the bank and is shown in the form of a percentage. The percentage rate is usually set as an annual rate.
Interest rate examples
Interest rates and loans
Variable rate loans
Variable rate loans mean the lender has the ability to change the rate up or down at any time (while respecting legal notice periods). Interest rates can be impacted by a range of factors such as the RBA cash rate, market conditions and cost of funds. Variable rates are not just limited to Home Loans.
Fixed rate loans
A Fixed interest rate is an interest rate that is fixed for a specific term, usually 1,2 3, 4 or 5 years. When the term expires, you will revert to a variable rate unless you opt to a select a new fixed term.
Principal and Interest
When paying off a loan you will be paying off the principal of the loan (actual money borrowed) and interest on the money borrowed. Over time the loan amount will reduce until it’s paid off.
Interest only
Interest only loans are loans where you are only paying the interest on the loan. The principal is not paid down. Interest only loans have a limited interest only period, usually up to 5 years, and then they would revert to a variable rate loan.
Interest rates and savings products
Term deposits
A Term Deposit is a deposit over a fixed term with a fixed interest rate which provides you with a low-maintenance, low-risk investment that earns interest without you needing to do a thing. Terms often range between 3 months and 5 years, providing you with a guaranteed return on your Term Deposit account. Term Deposits allow you to plan for your future and invest with confidence, in most cases you will receive a higher interest rate of return than many savings accounts over the same term. Once you have opened a Term Deposit your money is tied up in that account for the length of the term. If you withdraw funds before the end of the term you will likely be charged a penalty fee for breaking the term. Please ensure you consider the conditions before opening a term deposit.
Savings and transaction accounts
There are a wide range of transaction and savings accounts available in the market which offer different interest rates and features. These accounts are often referred to as ‘at call’ accounts, as your money is always available to withdraw at any time. Compare accounts and features. Some may require minimum deposits each month to ensure you earn the interest rate. Alternatively, you may forfeit interest if you withdraw funds from the savings accounts. Ensure you read all relevant information before opening one.
Learn more
The Reserve Bank of Australia’s website has some useful information on Monetary Policy and the Cash Rate.
