interest rates

The Reserve Bank may cut interest rates to very close to zero — so what does that mean for borrowers and savers?

PHOTO: Home buyers may be able to make money on their home mortgage loans.(ABC News: Ian Cutmore)

The Reserve Bank meets on Tuesday to decide whether or not to lower its cash rate target to 0.1 of a percentage point (from 0.25 percentage points).

That takes us very close to a negative interest rate.

But already some interest rates in Australia are negative — if you take account of inflation.

Annual inflation, as measured by the CPI, is currently 0.7 percentage points.

And as it stands, the effective overnight cash rate — that’s the interest rate the Reserve Bank attempts to influence every month and reflects the rate that banks lend to and borrow from each — is sitting at roughly 0.13 percentage points.

So the “value” of the money banks are lending out after adjusting for inflation is falling at roughly 0.7 per cent per annum (on the current rate of inflation), while the “rate of return” the banks receive from that money is well below that at roughly 0.13 per cent.

The banks’ money is being eroded over time, as opposed to growing — which is the effect of negative real interest rates.

Economists say this means the cash rate is “effectively” negative right now.

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