The RBA’s main tool is the cash rate. It’s an interest rate that affects the price of overnight loans between banks.
Banks then change the rates they charge customers.
Higher rates on home loans and business loans affect how much cash is available to spend by making it more expensive to borrow money.
That influences people’s behaviour and, therefore, the demand in the economy. And when demand drops, prices should go down, in theory. Or at least, stop rising as fast.
After a rate hike, households with variable home loans can be left making higher monthly minimum repayments — money they then can’t spend elsewhere.
If businesses have fewer willing customers, they will be less able to keep increasing prices, even as their own costs rise.
The RBA is effectively increasing one cost — the cost of your home loan — in an effort to contain others. It’s a hard pill to swallow when you’re just seeing your bills rise.
The central bank says higher rates encourage people to save more and spend less now, as they can earn more interest on their savings.
Asset prices, for example, stocks or housing, are also affected. Lower interest rates tend to drive up asset prices, making the people who own them feel wealthier and more likely to spend — and higher rates do the opposite.
And interest rates impact the exchange rate.
All else being equal, if Australia’s interest rates are higher compared to overseas counterparts, it lifts the value of our currency. More dollars flow into economies where you can earn more interest.
If our exchange rate rises, imported goods become cheaper. And if people consume more stuff from overseas, it can take some heat out of the domestic economy.