The Reserve Bank of Australia (RBA) plays a key role in shaping the Australian economy, and one of its most important levers is the cash rate. This rate influences everything from home loan interest to term deposit interest rates.
Key points covered
- RBA cash rate target vs actual rate
- Cash rate hikes and cuts’ effect on term deposits
- History of RBA cash rates
RBA cash rate meaning
The RBA cash rate is the target interest rate at which authorised deposit-taking institutions (ADIs) lend money to each other overnight. The RBA sets this rate to help guide the economy – either raising it to keep inflation in check or lowering it to stimulate spending and investment.
The RBA reviews the cash rate roughly every six weeks, looking at indicators like inflation, employment levels, and the state of global markets to decide whether a change in the cash rate is needed.
Cash rate target vs actual cash rate
The cash rate target is the interest rate the RBA sets to help steer the economy (it’s the rate they want financial institutions to use when lending money to each other overnight).
The actual cash rate is the real rate financial institutions charge each other in overnight loans. This is called the Australian Overnight Index Average (or “AONIA”).
While the RBA works hard to keep this actual rate close to its target, sometimes it can drift due to natural changes in the market.
How does it do this?
The RBA uses an “interest rate corridor system”. It works by setting a floor rate (the rate the RBA pays ADIs on overnight deposits via their exchange settlement accounts) slightly below the target, and a ceiling rate (the rate the RBA charges ADIs for loans) slightly above it. ADIs naturally stay within this range because borrowing above the ceiling or lending below the floor wouldn’t make sense financially.
To make sure there’s the right amount of cash in the system, the RBA also carries out “Open Market Operations”. These are daily market transactions to adjust the supply of money available to ADIs.
If there’s too much cash, rates could fall below the target; too little, and they might rise above it. The RBA’s management of these operations helps keep interest rates stable and predictable without needing constant intervention.
How the RBA cash rate affects term deposit rates
There is a clear connection between the RBA’s cash rate and the interest rates offered on term deposits by ADIs, though the relationship isn’t always simple. When the RBA changes the cash rate (or markets expect them to change interest rates through the swap market), ADIs often respond by adjusting term deposit rates (but not always to the same degree or at the same time).
Here are some cash rate factors that can influence term deposit interest rates
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Funding costs. If the cash rate rises, it becomes more expensive for ADIs to borrow money. Offering higher term deposit rates can attract savers’ funds, which ADIs use as a more affordable source of funding.
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Profit margins. ADIs need to balance the interest they pay savers with what they earn from lending, so changes in term deposit rates may reflect their attempt to maintain healthy margins.
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Competition. Competition between ADIs can result in some offering higher interest rates, even when the cash rate stays stable.
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Market conditions. Economic uncertainty can lead ADIs to offer higher term deposit rates to lock in funding, while in a strong economy, they may reduce rates.
How cash rate hikes affect term deposits
When the RBA raises the cash rate, term deposit rates typically start rising too. Higher rates often lead to more competition among ADIs, so you might find some attractive promotions or bonus offers during this time.
That being said, ADIs don’t always adjust their rates immediately after a cash rate hike. Sometimes they take time to assess how things play out across the market. Short-term term deposits often see rate increases sooner than longer-term ones as ADIs remain cautious about committing to higher rates (in case the cash rate changes again in the near future).
Additionally, cash rate expectations can influence term swap rates, which in turn affect term deposit rates, as both are fixed-rate instruments. In some cases, term deposit rates may even increase before an official cash rate move, reflecting these expectations.
How cash rate cuts affect term deposits
When the RBA cuts the cash rate, it typically doesn’t take long for ADIs to follow suit by lowering the rates on term deposits – you’ll often see changes within a few days or weeks. If the cash rate stays low for an extended period, term deposit rates tend to stay down too.
That said, if the cash rate move was unexpected, the response might be swift. However, when the move is anticipated, ADIs may have already factored the change into their pricing via the swap rate. The same considerations apply when rates go down as when they rise – ADIs may wait to see how the market responds and assess their funding needs before making adjustments.
RBA cash rate changes (1990 – 2024)
You can find more information on the historical shifts in the RBA cash rate here.
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