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 Financial Happenings Blog 
Thursday, March 29 2007

Reporting on interest rates has become a big part of the work of the financial media.

Every month there is breathless speculation about whether or not the Reserve Bank are going to increase interest rates, keep them on hold or decrease them.  Interest rate watch has become a big deal.

The futures market, where forward expectations of financial movements can be traded, is showing an almost 100% certainty of an interest rate rise within the next 6 weeks.  With a rise possible as early as next week.

So why are interest rates so important?

Interest rates can be best thought of as the 'cost of money' in the economy.  As money becomes more expensive, people become more reluctant to spend money and companies become more reluctant to borrow money for new projects.

There are three parts of the economy that are affected by interest rates:

  1. The amount of surplus money that households have available to spend
  2. The cost of future borrowing becomes higher, making people more reluctant to spend
  3. Companies have to pay more to borrow money, making them more reluctant to borrow for new projects and investment

All three of these factors tend to slow economic growth and demand when interest rates are increased.  Which is exactly what the Reserve Bank of Australia is trying to do when they raise interest rates.  They are trying to keep inflation - which can be thought of as a measure of demand for goods and services - at a rate of between 2% and 3%.  When inflation is getting too high they will raise interest rates to decrease spending.  When inflation is getting too low they will lower interest rates to increase spending.

Something that the media rarely mentions is that interest rate rises can actually be good for some people in the economy.  Consider retirees with a portion of their money invested in cash accounts.  As interest rates rise they receive an increase on their cash account earnings - which works out well for them!

The reserve bank meets on the first Tuesday of each month (next Tuesday) and then announces their decisions on the following Wednesday morning. 

Posted by: Scott Francis AT 06:08 pm   |  Permalink   |  Email
 
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