Cash rates are interest rates that financial institutions pay to borrow from the Reserve Bank of Australia (RBA), or charge to lend money in the money market (Bernanke, Olekalns, & Frank, 2011). These rates are fixed and maintained by the RBA in Australia. The bank has a mandate of fixing, measuring, and publishing these rates on a daily basis (‘Reserve Bank of Australia’, 2012).
RBA lowers cash rates
The rate of inflation in Australia has significantly dropped in 2012 prompting the RBA to cut interest rates to as low as possible (‘Reserve Bank of Australia’, 2012). In the year 2012, the inflation levels have slipped to lowest points ever witnessed in the last two decades. Prices of fruits and vegetables and other basic commodities have slide over the past eight months. Notably, the pattern of price slides is witnessed on imported goods whereas the prices of domestically produced goods and services are on the upward trend. The prices of rent, electricity, gas, and rates have constantly gone up in the same period (Martin, Nicholls & Zappone, 2012).
The turbulent global economic condition experienced globally is greatly contributing to the cuts in cash rates within Australia. The fairly moderate inflation rates coupled with slow global economic growth triggered the RBA to lower cash rate. This was from as high as 4.25 per cent at the beginning of the year to 3.50 per cent by mid 2012. In October of this year, the RBA lowered cash rates from 3.5 to 3.25 per cent. Some economic analysts noted that there might be further interest cuts before the end of the year (‘Reserve Bank of Australia’, 2012).
The RBA’s cash rate will be higher one year from now
However, it is tipped that this scenario is not going to hold for a long period given the volatility of the money market. According to Colebatch (2012), the cuts are not expected to go further in the next one year given the contracting economic status of the Eurozone. Colebatch (2012) argues that the economic conditions in the Eurozone will result in increased bond investment within Australia hence pushing the Australian dollar high. As expected, this condition event will increase the rate of inflation that will force RBA to adjust the cash rates upwards again to accommodate inflationary effects.
In its decisions to cut cash rates, the RBA is based on assumptions that the state of economic crisis is going to persist in Europe, the United States, and China. The bank assumes that inflation is going to remain unchanged hence the cash rates are going to be maintained, or further cuts can be made into 2013. However, there is a risk of inflation trends that may result from inflationary pattern in the global economy if the economic patterns in the Eurozone, China, US and other Asian countries continue. It is good to recognize that any negative trend in the global economy has a spill over effects on the Australian economy. If the financial crisis persists, the growth of the Australian financial sector will shrink thus necessitating an increase in cash rates to stimulate growth within the banking sector.
The cash rate cuts by RBA seem not to go down well with banks. Banks are not going to accept any further cuts in interest rates because such a move constrains their growth. The cuts in cash rates increase demand for money within the economy for investment purposes. This is especially in the real estate (Bernanke, Olekalns, & Frank, 2011). This is expected to generate additional demand pressures for funds that will instigate inflation above the target levels hence prompting rising of cash rates.
The recent cash cuts by the RBA are not expected to continue beyond the next one year. It will be quite risky for the bank to go on with the cuts based on the likely effects of such action. The global financial and economic turmoil, which is unpredictable, is likely to force the cash rates up again one year from now.
Bernanke, B, Olekalns, N & Frank, R 2011, Principles of macroeconomics, McGraw-Hill, Sydney.
Colebatch, T 2012, “The reserve Bank’s view of the year ahead foresees the economy growing trend”, Business Day, Web.
Martin, P, Nicholls, S, & Zappone, 2012, “Inflation fall clears way for more rate cuts” Business Day, Web.
Reserve Bank of Australia 2012, Web.