There is always a debate in the market about what the next move in the cash rate would be. So what are the factors that the Reserve Bank of Australia (RBA) evaluates when determining interest rate rises or cuts?

Inflation

Inflation is the rising price of goods and services. When inflation occurs, the purchasing power of the consumer is diminished as the cost of living has increased. The RBA monitors inflation and will take into account inflation figures when deciding on interest rate movements. If the RBA thinks inflation is too high they will raise interest rates to slow the economic growth, if they think inflation is too low, they will cut interest rates to boost economic growth.  The target inflation rate is currently 2 – 3 per cent.

Unemployment

If the RBA sees unemployment as being too high, there is a higher probability they will cut interest rates. This is so businesses can expand further and create jobs.

Wage Growth

Weak wage growth is a factor for the RBA to consider as without higher wages, household consumption is limited. Growth in household debt has been rapid and wage growth has not increased to the same level as housing inflation. For the economy to strengthen, wage growth needs to catch up with house price growth.  These factors remain impeding concerns for inflation.

Household debt

As many Australians have borrowed large amounts for their homes, the RBA will need to take this into consideration as interest rate rises will affect these households immensely.  The RBA has a difficult balancing act of stimulating the economy but also doing it in a way that so it does not jeopardize these highly leveraged households.

The Australian dollar

The RBA monitors the Australian dollar and adjusts the interest rate in accordance to how the exchange rate is performing. If the cash rate is too high then it will encourage investors to invest in the Australian dollar pushing the exchange rate higher. If the Australian dollar is too high then Australian exporters will find it hard to stay competitive in international markets as their goods would be more expensive compared to countries.

Consumer Confidence Index

The RBA will look at this index as an indicator of the level of optimism consumers feel about their personal financial situation. Consumers will spend money on goods and services which increase economic growth when confidence is high. When confidence is low, consumers are more likely to save money and in effect hamper economic growth.

Lauren Hua is a private client adviser at Fairmont Equities.

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