Who really controls your interest rates?

Does the Reserve Bank really have control over home loan interest rates? Most believe the Reserve Bank has ultimate control over interest rates. Every month, mortgage holders anxiously await the outcome of the RBA’s monthly board meeting.

This experience is like servicing the family car and waiting for the bill. The job is done and you know you have to pay for it no matter what but as the mechanic starts explaining he adjusted the ‘Pressure Feedback EGA Sensor’ and tightened the support bolts on the ‘A/C Clutch Field Coil’ you start thinking this is going to be expensive, but then he doesn’t charge you as it only took a minute to fix. You drive home feeling like you’ve just won the lotto.

To understand who has ultimate control over your interest rates lets consider a shop owner who sells kitchen tables. If building a kitchen table requires one plank of timber at a cost of $200 the shop owner does not sell it for $200.

The same principle applies to money. If a bank buys money for 2%, it will not sell it for 2%. Just like the shop owner, the bank must cover its costs and provide profit to its owners, otherwise it is just a charity.

The shop owner can sell the kitchen table for whatever price he or she wants regardless of the raw cost of timber. If timber prices stay the same but cost of screws increase, the shop owner will increase the price of the table.

Likewise if a rival furniture retailer sells the same table cheaper, the original shop owner reduces the price to compete. If the shop owner doesn’t manage this process well, they could soon be out of business.

Our banks operate exactly the same way and behave in the same manner as the shop owner, so next time your home loan rate changes ‘Out of Step’ with the reserve bank, just look at your kitchen table and think to yourself, maybe the price of screws have gone up.

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