Philip Lowe, Governor of the Reserve Bank of Australia (RBA) announced a further cut to the cash rate down to 0.1% on 3 November 2020. This is a 0.15% reduction from 0.25%, which was held since March 2020. This is broadly in line with market expectations and brings Australia’s official interest rate in line with rates in comparable countries (which is around zero). For investors, it means lower rates for longer, with a rate hike unlikely in the coming years.
What is driving the latest easing?
Put simply, the RBA’s economic forecasts show that it does not expect to meet its inflation and employment objectives over the next 2 years and sees the recovery as being bumpy and drawn out. The RBA has been undershooting its 2-3% inflation objective for the last 5 years now.
Will the banks pass on the RBA rate cuts?
Passing all of the 0.15% cut will bring some downward pressure on bank profit margins as a significant chunk of deposits are already at or near zero rates. However, I believe the banks will pass most of it on as they will be under pressure from the RBA and the government who have been providing them with a lot of support (including cheap funding which is now 0.15% cheaper). If they do not, they will face public backlash.
Implications for investors?
There are a number of implications for investors from the latest easing by the RBA.
First, ultra-low interest rates will likely be with us for several more years, keeping bank deposit rates unattractive, so it is important for investors in bank deposits to assess alternative options.
Second, the low interest rate environment means the chase for yield is likely to continue supporting assets offering relatively high sustainable yields. This is likely to include Australian shares where despite sharp cuts to dividends, the grossed-up for franking credit dividend yield on shares remains far superior to the lower yield on bank term deposits. Investors need to consider what is most important; getting a decent income flow from their investment or absolute stability in the capital value of that investment. Of course, the equation will turn less favourable if economic activity deteriorates again.
Third, the ongoing decline in mortgage rates along with easing lending standards will help boost house prices, but bear in mind that high unemployment and a hit to immigration will likely impact throughout the year ahead. The housing outlook also varies dramatically between cities given the rising demand for outer suburban and regional houses over inner city units.
Finally, lower rates and increased quantitative easing will help keep the Australian Dollar lower than otherwise, but it is still likely to rise over the year ahead if global recovery continues and this pushes up commodity prices.
If you are not satisfied with the interest rates on your savings or require assistance in reducing the interest rates on your mortgage, please speak to your financial adviser or a mortgage broker.
Please note this article provides general advice only and has not taken your personal, business or financial circumstances into consideration. If you would like more tailored advice, please contact us today.