The recent drops have come faster and dropped further then ever before. The rates are currently some of the lowest that have been available in nearly twenty years.
These “interest rate cuts” have become more newsworthy during the recent economic crisis because the Reserve Bank has dropped rates at an alarming rate. When the economy is healthy there are still small interest rate cuts and rises. Typically the interest rate will move up or down by .25 percent. However, these movement are slow and far between. It took the Reserve Bank of Australia almost six years to get interest rates up to the level they were before they started dropping them to record low rates. Those drops happened in about three months.
In order to understand how an interest rate cut might affect you personally you must first understand why the rates change at what factors affect those changes. Policymakers in the government use an interest rate cut to help regulate the amount of money available in the economy. Here in Australia it is done by the RBA, in the United States it is their Federal Reserve Bank and in the European Zone it is ECB. These central banks each have the power to regulate interest rates based on economic conditions and future forecasts. Based on these factors they choose whether to raise or decrease interest rates. They are also able to buy and sell securities backed by the government as another interest rate control. Cutting interest rates is a way to comb at inflation and stimulate economic growth.
What causes an interest rate cut?
When inflation rates are high the central banks of any given country will cut the interest rate. By cutting the rate they make it cheaper to borrow money and increasing demand for good. This process in turn reduces the costs of production which helps to curb inflation. The relationship between inflation and an interest rate cut is considered to be an inverse relationship.
- Government borrowing
The central bank of a country is that countries biggest borrows. They borrow from the central bank in order to run government programs or to manage policy changes. When the government demand for these loans is low it lowers the pressure on interest rates, in turn when the demand is high it puts upward pressure on interest rates.
- Global conditions
We live in a world that is completely interconnected so what happens in one country usually affects what happens in all of the major economies. In many cases it is the United States dollar that is primarily used for international trade. When the value of the United States dollar rises and falls it can impact domestic economies causing their banks to raise or decrease interest rates.
An interest rate cut can also effect the stock market. When rates decrease consumers are encouraged to borrow money from banks. Companies make financial investments of companies and other plans for expansion because of the lower rates. Both of these actions increase the amount of money in the economy and boost spending. This boost helps to move the stock market upward and has a positive affect on the prices of stock. By the same token, an interest rate cut could lead to a loss in earnings for people who have money deposited in banks or invested in equities. But, if your money is in bonds, those prices get a boost from the cuts.
How an interest rate cut affects you
Now that you understand all about an interest rate cut you are probably still wondering how it directly affects you, the consumer. Aside from affecting you because of the overall impact it has on the economy it also affects how much or how little a mortgage will cost. The impact of the cost of mortgages is a huge factor in how much money everyone has to spend and the stability of the economy. When rates fluctuate it controls how much money there is in household budgets, in turn affecting how much money is spent in the community. It is truly all connected.
- Home owners
If you already own your home an interest rate cut can lead to more money in your pocket because it decreases the cost of your mortgage. We say can because banks are not required to pass the full interest cut down to customers, although they often do. Sometimes it is less then the full cut or sometimes banks will pass on none. However, with a variable interest rate loan you should be able to feel the affects of most interest rate cuts.
- Home buyers
If you are in the market for a home loan it might seem like the ideal time to buy when interest rates are low. That is true, but only in the short term. Here in Australia rates can only be fixed for three to five years. If you take out a mortgage when rates are very low you could see a rise in your mortgage amount as rates increase. Buyers must be careful to buy a home that they can afford even when rates increase.
An interest rate cut is often a good thing for the economy because it helps put more money in the system. Just be aware that as it falls it can also rise, so protect yourself by taking out loans you can afford even when the rates go back on the rise.Back to top