Why rates rise and fall

The Reserve Bank and its counterparts the world over use short-term variable interest rates to slow down or speed up the economy and control inflation. If these rates remain too low for too long, the rate of spending and borrowing can outstrip the economy's productive potential. The result is rising inflation and the risk of an overheated economy.

Why only small rate movements are expected in the future

Through the 1970's until late 1990's the economy went through many boom and bust cycles. They were characterised by rapid inflation, followed by rapid interest rate rises, followed by recession. During these cycles the market would peak and the economy would falter and inflation that had accompanied economic growth abated. During economic recessions the Reserve Bank reduced interest rates to stimulate the economy.

For the last decade, since early 2000 the interest rates continued to fall as the Australian economy lifted productivity (i.e.: grew without inflation rising). This change from the previous 30 years of the boom bust cycle, encouraged the belief that the factors which caused the high interest rate changes were finally brought under control.

In summary the case for and against a rate rise

For:

• The Reserve Bank still believes household borrowing (mortgages, credit cards, car loans) is increasing at an unsustainable rate.
• Inflation pressures, particularly higher oil (energy) prices, rising wages and retail spending.
• Interest rates are rising around the world.

Against:

• Underlying inflation is still low (2 per cent)
• Real growth in wages is arising from increased productivity and hence not increasing inflation
• The housing market and lending for investment properties is slowing
• Economic growth is forecast to slow in the second half of 2004
• Some parts of Australia are still drought affected.

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