Each year, the Reserve Bank meets eight times to decide whether to increase, maintain or reduce interest rates. The decision affects 3.2 million Australians with owner-occupier mortgages and has knock-on effects across the economy, but what factors influence whether the cash rate goes up or down? Here’s what you need to know.
The Reserve Bank meets eight times a year to decide how to adjust interest rates. (Louie Douvis/AFR)
How does inflation impact interest rates?
If there is one factor that has the biggest influence on interest rates, it is inflation. The Reserve Bank of Australia is tasked with keeping inflation between 2-3%. The tool it uses to achieve this is the interest rate: raising the cash rate to reduce demand and theoretically curb price growth, or lowering the cash rate when inflation is too low to give households more spending power and increase inflation. While the Australian Bureau of Statistics does publish monthly Consumer Price Index (CPI) data, the quarterly figures are generally considered to carry more weight.Aside from the headline inflation data, a key statistic to watch is the ‘trimmed mean’. It excludes the most volatile price changes and is therefore a good measure of ‘underlying’ or ‘core’ inflation, and one of the key figures the RBA watches. If it moves back towards target then there is a good chance that interest rates will follow.
Inflation is the biggest factor affecting the cash rate. (Kate Geraghty)
How does the unemployment rate impact interest rates?
Another important factor in the interest rate equation is the unemployment rate. According to the RBA’s charter, the central bank must strive to “maintain full employment in Australia”. Generally speaking, if the unemployment rate rises, the likelihood of a rate cut will also increase, because loosening monetary policy is usually conducive to bringing more jobs into the market.High unemployment is also typically associated with a weak economy — another reason it’s associated with rate cuts. But the situation in 2024 is slightly different, with unemployment remaining at historically low levels despite widespread weakness in the rest of the economy. “This has all been disrupted by a once-in-a-century pandemic,” Michele Bullock, the governor of the Reserve Bank of Australia, said in May.
Higher unemployment generally means a greater likelihood of rate cuts, but it’s not always a smooth sailing. (Kate Geraghty) “I think our history of unemployment and how it reacts is not based on this kind of shock that’s happened in the economy.” So it’s not always a simple equation, and as Bullock noted in November, getting inflation back to target is often more important than unemployment. “(The unemployment rate) is important,” RBA Governor Michelle Bullock said after the November meeting.“We have a dual mandate, but ultimately we’re not going to be able to deliver very well on our jobs mandate if inflation gets out of control.” “So we do need to make sure we get inflation down.” It’s also worth noting that there are still a large number of economic factors that ultimately play a role in setting interest rates, including consumer spending, international financial conditions, household debt, and more. The information provided on this website is of a general nature only and does not constitute personal financial advice. The information has been prepared without taking into account your personal objectives, financial situation or needs. Before acting on any information on this website, you should consider whether the information is appropriate in light of your objectives, financial situation and needs.