The Reserve Bank of Australia chose to raise interest rates this week. As the RBA weighs further tightening, a key question will be how strongly interest rate changes feed into household spending.
The transmission of monetary policy in Australia is thought to run partly through the cash flow of mortgage borrowers. Lower rates reduce interest repayments, lift disposable income and thereby support spending. Higher rates do the reverse. With high levels of mortgage debt and widespread variable rates, this “cash flow channel” is generally seen as central to how monetary policy works in Australia.
But recent e61 research suggests that the cash flow channel is currently weaker than many assume – both for interest rate increases and decreases.
Using de-identified, consented and aggregated bank transaction data for December 2024 to April 2025, we studied the effect of the cash flow channel following the February 2025 rate cuts.
The first step worked exactly as textbooks predict. Average mortgage interest charges fell by about $140 per month. That was a meaningful lift in household cash flow.
But the second step did not follow. Only 10 per cent of households reduced the size of their regular mortgage repayments after the cuts. This pattern was consistent across institutions, including at one bank that automatically lowers scheduled repayments for borrowers paying the minimum.
Two factors help explain why lower interest charges did not translate into lower mortgage repayments: mortgage repayment inertia and the building of liquidity and prepayment buffers.
Repayment inertia describes a situation in which individuals do not adjust their actual repayments in line with required repayments.
When rates fall, minimum repayments can decline, although most Australian banks do not automatically change the repayment schedule. For these institutions, borrowers must request a repayment reduction. If a borrower leaves their total repayment unchanged, the difference becomes an additional principal reduction. The rate cut is automatically converted into higher saving through faster mortgage amortisation.
The widespread nature of this inertia in repayment flows is visible in the data. For one large bank where we observe minimum repayments directly, 39 per cent of accounts had repayments within $10 of the minimum before the cuts, though only 4 per cent paid exactly the minimum. After the cuts, most borrowers left repayments unchanged. The share of accounts close to the new, lower minimum fell to just 8 per cent.
Liquidity and prepayment buffers are extra cash that households accumulate over time in offset and redraw accounts.
Borrowers with larger liquidity buffers are less likely to adjust their spending when required repayments change, because they can more easily smooth spending in the face of fluctuations in cash flow.
The importance of these liquidity buffers has changed over the cycle. At the start of the 2022 tightening phase (immediately post COVID), they were unusually large. Many borrowers could cover required repayments for extended periods without cutting consumption. That served to blunt the spending response to higher rates.
Those buffers were run down during the hiking cycle and by the time of the 2025 rate cuts, many borrowers had relatively thin buffers. The cuts since then have partly been used by households to rebuild those buffers. Research suggests that a 100-basis point reduction in interest rates is associated with a ½ per cent increase in mortgage buffers after 6 months, on average.
Notably, aggregate statistics suggest that much of the growth in mortgage buffers over recent years has been due to borrowers putting money in their offset accounts rather than redraw accounts. This suggests that borrowers have kept some of the additional cash flow aside for precautionary reasons rather than to pay down their mortgages faster.
As a result, the picture heading into 2026 is different from 2022. Buffers are no longer at the exceptionally high levels seen at the start of the earlier hiking cycle, even though most households still retain meaningful financial cushions. About 11 per cent of borrowers have large enough buffers that they could cover their median monthly spending for at least 2 years.
Survey evidence is consistent with that interpretation. According to the latest estimates from the HILDA Survey for 2024, at the peak of the previous tightening cycle only about 2 per cent of mortgage borrowers reported being behind on their repayments, while more than half said they were ahead. This suggests that, although buffers have been eroded from earlier highs, most borrowers are not right up against their cash flow limits.
The macro implication is that the latest interest rate rise will likely have a limited impact on spending through the cash flow channel. Most of the reduction in cash flow will be met by lower saving and reduced mortgage buffers. Household spending will continue to be insensitive to further interest rate hikes, so long as the buffers are not eroded too much.
When repayment inertia is high and liquidity buffers remain prevalent, the path from the cash rate to the checkout counter is slower and runs more through mortgage balances than shopping baskets.
