Understanding the Official Cash Rate and its impact on home loan borrowers

The official cash rate is more than just a number—it’s a key driver of mortgage rates, savings returns, and overall economic stability. Whether you're a homeowner, investor, or saver, changes in the cash rate have an impact on your financial well-being.

But how does the official cash rate actually work? Why does the RBA adjust it? And most importantly, how can you stay ahead of rate changes to make smarter financial decisions? In this guide, we tell you more about the official cash rate and its real-world effects.

What is the Official Cash Rate?

The official cash rate is the interest rate set by the Reserve Bank of Australia for overnight lending between banks. It serves as a benchmark, shaping mortgage rates, business loans, and overall borrowing costs.

The RBA adjusts the cash rate to control inflation, support employment, and maintain economic stability. When inflation rises too fast, the RBA may increase the rate to slow spending. If economic growth slows or unemployment rises, it may cut the rate to encourage borrowing and investment.

Banks use the official cash rate as a reference when setting their own interest rates. This means changes to the cash rate directly impact mortgage repayments, savings returns, and broader financial conditions.

How the RBA sets the Official Cash Rate

The RBA plays a pivotal role in shaping the country's economy, and one of its key responsibilities is setting the official cash rate. Let’s break this down into simpler terms to help you understand how this process works and why it matters.

Who decides the cash rate?

The RBA’s Monetary Policy Board is tasked with determining the cash rate. This board includes:

• The RBA Governor
• The Deputy Governor
• The Secretary to the Treasury
• Six other members appointed by the Treasurer

These experts meet eight times a year to decide whether to raise, lower, or keep the cash rate steady. These meetings are carefully timed to follow major economic data releases, such as inflation figures and employment reports.

What guides their decisions?

The RBA has clear goals when setting the cash rate:

1. Keep inflation between 2-3% – This ensures prices don’t rise too quickly, preserving purchasing power.
2. Support full employment – The aim is to create a strong job market where most Australians who want work can find it.
3. Maintain economic stability – This involves balancing growth while avoiding booms or busts in the economy.

To achieve these objectives, the board examines a wide range of factors, including:

• Inflation trends: Are prices rising too fast or staying stable?
• Employment data: How are job creation and unemployment rates looking?
• Economic growth: Is the economy expanding or slowing down?
• Consumer and business confidence: Are people feeling optimistic about spending and investing?
• Global influences: What’s happening with interest rates in major economies like the US?
• Australian dollar performance: How is it faring in global markets?
• Property market trends: Are housing prices and borrowing activity heating up or cooling down?

How does the RBA keep the cash rate on target?

To keep the cash rate near its target, the RBA uses an interest rate corridor system:

• Banks can deposit money with the RBA overnight but earn slightly less than the target rate.
• Banks can borrow money from the RBA overnight but pay slightly more than the target rate.

This system keeps the cash rate within a controlled range, preventing big swings. The RBA also manages liquidity in financial markets through open market operations, adjusting cash supply to steer rates toward its target.

Why should you care about the cash rate?

Changes in the official cash rate typically influence the interest rates that banks charge for mortgages in Australia . The official cash rate serves as a key benchmark that affects the cost of funds for financial institutions, and these costs are often passed on to consumers through adjustments in lending rates, including those for home loans.

Generally, a decrease in the official cash rate tends to lead to lower mortgage interest rates, making borrowing more affordable and potentially stimulating activity in the housing market. Conversely, an increase in the cash rate typically results in higher mortgage interest rates, which increases the cost of borrowing and can act to moderate the housing market .  

The extent and timing of the impact on individual borrowers depend on the type of home loan they have. Borrowers with variable interest rate mortgages will typically see their repayments fluctuate in line with changes to the official cash rate, although the adjustment by lenders may not always be immediate or precisely equal to the RBA's change . On the other hand, borrowers with fixed interest rate mortgages will not experience any change in their interest rate or repayments during their fixed term, regardless of movements in the cash rate change.

While the cash rate is a primary driver influencing mortgage rates, it is important to note that banks also consider other factors when setting their lending rates, such as their own funding costs, competitive pressures within the market, and their assessment of the risk associated with lending . The RBA strategically uses the cash rate to influence overall demand in the economy; lowering rates encourages borrowing and spending, while raising rates aims to control inflation by making borrowing more expensive .  

Official cash rate vs. mortgage interest rates

The official cash rate and mortgage interest rates are closely linked but not the same. As mentioned, the official cash rate is the interest rate on overnight loans between commercial banks. In contrast, mortgage interest rates refer to the rates charged by lenders, such as banks and other financial institutions, to individuals and entities for borrowing money to purchase property.  

The Reserve Bank of Australia sets the cash rate as a tool to manage inflation, employment, and economic growth. It directly affects the cost of borrowing between banks but does not dictate the rates lenders offer to consumers.

Mortgage interest rates, on the other hand, are set by individual banks and lenders based on multiple factors beyond the cash rate. While lenders often adjust their rates in response to RBA decisions, they also consider their own funding costs, market competition, and risk assessments.

Key differences include:

• Who sets the rate? The RBA controls the OCR, while banks and lenders set mortgage rates.
• What it affects? The OCR influences short-term interbank lending, while mortgage rates affect home loans directly.
• How it changes? The RBA adjusts the OCR based on economic conditions, but lenders may or may not pass these changes on to borrowers.
• Other influences: Mortgage rates are also affected by global interest rates, the cost of wholesale funding, and lender-specific pricing strategies.

Understanding these differences is crucial when you're shopping around for a home loan or trying to predict how your repayments might change over time.

Is another rate cut on the cards?

When the RBA recently cut the official cash rate, the big four banks—ANZ, Commonwealth Bank, NAB, and Westpac—responded by lowering their variable home loan rates by 0.25%. But is their further relief on the horizon for borrowers?

The good news is, the consensus among those big banks seems to be "yes!" Looking ahead to the rest of 2025, all four are predicting further cuts to the cash rate, which should translate to lower mortgage rates down the line. Here's a quick rundown of what they're expecting:

• ANZ: Anticipates at least one more cut, potentially bringing the cash rate down to 3.85%.
• Commonwealth Bank: Foresees a series of cuts throughout 2025, possibly reaching 3.35% by the end of the year.
• NAB: Also expects multiple cuts, with some forecasts suggesting the cash rate could land around 3.35% by the end of 2025.
• Westpac: Similar to CBA and NAB, Westpac anticipates gradual easing throughout 2025, predicting a cash rate of 3.35% by year's end.

What does this mean for you?

If these predictions hold true, Aussie mortgage holders with variable rate loans can likely expect to see their monthly repayments decrease over the coming months. However, remember that these are just forecasts, and actual mortgage rates will depend on a variety of factors considered by individual lenders. Keep an eye on RBA announcements and lender movements to stay informed!