What the RBA rate cuts mean for investors

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When the cash rate was recently cut to an historic low of 0.75 per cent – below one per cent for the first time in Australian history – the Reserve Bank of Australia (RBA) made it clear that further cuts could be on their way. Why is the RBA in rate-cutting mode and what does it mean for investors? 

“While the outlook for the global economy remains reasonable, the risks are tilted to the downside,” the RBA said1. “The US–China trade and technology disputes are affecting international trade flows and investment as businesses scale back spending plans because of the increased uncertainty.”

Considering the local economic climate, says Ryan Felsman, Senior Economist at CommSec, the RBA was right to cut interest rates in an attempt to boost consumer confidence.

The Australian economy has slowed to its weakest annual growth rate since September 2009, at just 1.4 per cent, he says. 

Unemployment, having dipped to eight-year lows in February 2019 at 4.95 per cent, has jumped back up to 5.3 per cent over the last few months.

“What the Reserve Bank would like to see is a lower jobless rate of around 4.5 per cent, where you’d expect to see economic activity strong enough to generate some wages growth,” Felsman says.

The intention of the low interest rates is put simply, to encourage households to spend more by reducing the currently pronounced caution amongst consumers, he says.

Removing the barriers to spending

With mortgage rates dropping to 50-year lows, as well as tax offsets or tax cuts available to around 10 million Australians, the expectation is that consumers will have greater cash flow so should spend more. That spending will stimulate the economy and create more, higher-paid jobs, says Felsman.

“But, of course, there are challenges around all of this,” he says. “Consumers are contending with other factors such as elevated petrol prices and high electricity prices.”

Hence the indication from the RBA that more cuts could be on their way. CommSec is currently forecasting a base cash rate of 0.5 per cent for February 2020.

Where then, are the investment opportunities in such a low-interest environment? This is a popular discussion point right now, Felsman says.

Investment opportunities

“Pension funds, particularly self-funded retirees, are looking for alternative ways of achieving yield in order to supplement their incomes,” Felsman says. “With term deposit rates so low, investors are increasingly looking to the share market, where the average dividend yield amongst the ASX top 200 companies is about 4.5 per cent.”

As the bond market has rallied, Australian government bonds have this year seen a return of around 11 per cent, he says.

“People are also now looking more aggressively at alternatives such as infrastructure investments, particularly with support from governments in terms of government spending,” he says. 

“Another alternative is around private equity. That range of asset classes is attractive in terms of the fact that they’re high yielding.”

Finally, there is the argument that a low-interest period could be used to pay down mortgage debt, with the extra cash flow being funnelled back into the mortgage. While this doesn’t achieve the goal of increasing consumer spending, it does reduce financial risk and therefore increases consumer confidence, says Felsman.

“The consumer is the key ingredient as far as the economy is concerned. The hope is that the lower interest rates will stimulate more economic activity and lead to greater hiring, which leads to wages growth, which leads to inflation.”

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Important: This article has been prepared without taking account of the objectives, financial or taxation situation or needs of any particular individual. Before acting on the information, you should consider its appropriateness to your circumstances and if necessary, seek appropriate professional advice. Any information used in this article is for illustrative purposes only. Past performance is no guarantee of future performance.

1Statement by Philip Lowe, Governor: Monetary Policy Decision, Number 2019-27, 1 October 2019