Problem
Article: Westpac first to respond to rate rise by Ayesha de Kretser and James Eyers
The surprise 50-basis-point increase in the Reserve Bank of Australia's cash rate will almost certainly be passed through to mortgage holders which would mean repayments on a $500,000 debt increasing by $133 a month - as banks work to restore net interest margins squeezed when rates hit rock bottom.
But since many borrowers are ahead on repayments, or have taken out fixed-rate loans, it could take some time before many households feel the pinch.
Westpac was the first of the major banks to pass through the RBA rate rise, after the central bank went harder than expected to set a new cash rate target of 0.85per cent, up from 0.35 per cent, sending bank stocks sharply lower.
Westpac said its variable interest rates would also lift by 0.50 per cent for new and existing customers. None of the other major banks had announced a move by 7:30pm AEST.
Even as banks push standard variable rates higher, this does not mean all customers have to lift their monthly repayments, allowing many households to maintain their budgets - and raising questions about how quickly the so-called "transmission mechanism" to tame inflation will take effect.
This is because all the big four banks kept customers' monthly loan payments steady as the cash rate fell - unless customers asked them to drop it. This allowed most borrowers to get ahead on repayments by paying off more of the principal from their loans with the same monthly repayment.
Now that rates are rising, banks will do the same thing. They will maintain existing monthly repayments for customers who are ahead, but more of that repayment will go towards interest rather than paying off the principal.
Read the above article and answer the following questions.
I. Outline what type of monetary policy the RBA has adopted in that period.
II. Why did Westpac increase its interest rates?
III. Explain the expected impact of this change on the inflation rate.
IV. Why is the monetary policy considered flexible?