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What is the RBA?
The Reserve Bank of Australia (RBA) is the central bank of Australia, whose express function is to support and enhance the economic and financial stability of the country.
RBA derives its mandate from the Reserve Bank Act of 1959 that granted the bank powers to contribute to the stability of the Australian dollar, to achieve full employment and to drive economic prosperity.
Furthermore, the RBA is also tasked with managing Australia’s gold and forex reserves. The RBA also provides central banking services to the Australian government and its various agencies as well as to foreign partners.
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The RBA, in its current form, exists courtesy of the Reserve Bank Act of 1959 that took effect on January 1960. Before that, there existed the Commonwealth Bank of Australia, which was established by legislation in 1911.
The functions of the Commonwealth Bank were limited to savings and commercial banking services. At the time, central banking services, such as note issuing, were offered by the Australian Department of Treasury.
Several legislations would follow, and by 1945, the Commonwealth Bank would be given full and formal powers to provide central banking services to the Australian people.
The functions would include but were not limited to, the administration of monetary and fiscal policy, note issuance, and exchange control.
Since it took over in 1960, the RBA has overseen major milestones in the Australian financial scene. In 1966, the Australian pound was retired for the Australian dollar (AUD).
The AUD would be pegged to the US dollar until 1983 when it then started floating freely in the market. The AUD is now a major global currency, and the RBA is one of the most influential central banks in the world. The RBA is headquartered in Sydney, Australia, but it has multiple offices around the country.
The Reserve Bank of Australia is an autonomous body (independent of government) and consists of two boards:
Reserve Bank Board
The Reserve Bank Board has responsibility in the following areas:
- Stability of the Australian dollar,
- Full employment of the Australian people, and
- Economic prosperity and welfare of the Australian people.
Payments System Board
The Payments System Board has responsibility in the following areas:
- Promotion of competition in the payment services market,
- Enhancing the efficiency of various payment systems, and
- Controlling risk in the financial system.
The RBA is managed by a Governor, who chairs both the Reserve Bank Board and the Payments System Board.
Functions and Roles of the RBA
In terms of its functions and its roles, the Reserve Bank of Australia is responsible for the following:
- Setting the cash rate. This is the most impactful role of the RBA. The bank meets every first Tuesday of every month (except in January) to set the cash rate, an activity that impacts literally every economic facet of the Australian economy.
- Note Issuance. The RBA produces and distributes Australia’s banknotes, which serve as legal tender both locally and internationally.
- Banking. RBA is the official banker of the Australian government, which essentially means that it manages and supports several government services such as social security, defence, or even Medicare.
- Payments. RBA also supports, alongside other banks, Australia’s New Payments Platform, which facilitates round the clock payments processing among various financial institutions.
- Promoting financial stability. RBA is an active participant in the financial markets for the sole purpose of promoting stability by ensuring liquidity remains stable.
- International markets operations. In addition to managing Australia’s Forex trading reserves, the RBA is also the country’s representative in global forums such as the G20, the International Monetary Fund, and the International Bank of Settlements.
RBA in Fundamental Analysis
The RBA has a massive influence on both local and international financial assets. The interest rate decision delivered by the RBA every month is arguably the most important event watched by fundamental analysts.
The event usually has the potential of triggering massive price movements in underlying assets. For the most part, the RBA has maintained an inflation target of 2-3%, which it strives to keep using all the tools at its disposal. Interest rate changes are the most potent tool in its arsenal, and here is how it affects the pricing of major financial assets:
Interest rate hikes hinder both business and consumer spending while increasing the cost of the national currency, which under normal conditions, causes stock prices to fall. The reverse also applies, with rate cuts inspiring higher stock prices.
Like stocks, bonds also usually have an inverse relationship with interest rates. Higher rates cause bond prices to fall, while lower rates cause bond prices to rise.
The Australian Dollar (AUD)
The AUD is a major currency in the global financial markets. When the RBA hikes interest rates, it is essentially limiting the supply of the currency, which will make the AUD price rise. Conversely, when the RBA applies a rate cut, it basically increases the supply of the AUD, which consequently decreases its value.
RBA Quantitative Easing
The interest rate is a conventional monetary policy tool, but it’s not the only one, the RBA has implemented unconventional measures to help cushion and support the Australian economy.
In particular, quantitative easing, which involves the RBA buying assets such as treasuries from the government and other financial institutions, has been prominent. Quantitative easing has helped navigate the worst effects of the recent catastrophes, such as the 2008 financial crisis and the 2020 coronavirus pandemic.
RBA Forward Guidance
Forward guidance is also an unconventional monetary policy tool which involves the communication of the RBA monetary stance. In the RBA’s case, the stance has always been maintaining an inflation target of 2-3%.
Reserve Bank of Australia main FAQs
How does the RBA influence interest rates?
The RBA sets the cash rate in Australia, which is the overnight interest rate charged for money market loans. The RBA meets in every month (except January) to decide whether to keep the cash rate the same, to raise it, or to lower it. It makes this decision based on its analysis of the state of the Australian economy. While the cash rate isn’t the same as the rate paid by consumers on mortgages and other consumer loans banks will often decide to pass along the changes in the cash rate to consumers and businesses. This can make borrowing more or less expensive, with a corresponding impact on economic growth, consumer spending, and business activity
Why does the RBA change the cash rate?
The RBA does not have any policy that specifies where interest rates should be. However, since the cash rate in an intermediate objective of monetary policy it can be used to achieve the primary objectives of currency stability and sustainable economic growth. The cash rate is used to influence inflation and employment levels in Australia, hopefully steering the economy to full employment and low, but stable inflation. The RBA announces its cash rate changes in an effort to provide markets with transparency, which reduces uncertainty regarding monetary policy and the future of the Australian economy.
How does the RBA impact the Australian economy?
When the RBA moves to lower the cash rate it will cause other short-term interest rates in the economy to fall. This stimulates borrowing and spending within the economy. As a result, business output will typically increase, and this results in increased economic activity and employment. When the uptick in economic activity is strong enough it can also cause an increase in inflation. The opposite is also true. When the cash rate is increased it acts to curtail economic activity, hopefully leading to lower inflation. An unwanted side effect is often lowered employment.
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