Don’t Turn A Blind Eye To The RBA’s Interest Rate Hold

watching economy eagerly

It’s the one financial number that everyone used to pay attention to.

And I mean everyone.

From the young couple looking to buy their first house, to the retiree looking to make an income for herself.

In the financial markets, professionals dedicate whole careers to working out minor variations on this number.

Any small advantage means billions of dollars of profit for the firm. Not to mention millions of dollars of commissions for the trader.

Businesses make billion dollar project decisions based on this number.

I’m talking, of course, about interest rates.

But from the coverage of yesterday’s Reserve Bank decision, you wouldn’t guess any of this.

What used to be a lead news story — complete with stock image of hunched over trader shouting ‘no change’ on a crowded trading floor of computer screens — was reduced to number four or five story, by my guess.

In fact, when I mentioned to a friend that I would be writing about interest rates at work, their response was, ‘Isn’t the RBA decision due soon?

Clearly this topic is off the radar of the mainstream news for some reason.

So what gives?

And what’s happening next?

Well, part of the disinterest is based on this.

There’s pretty much been no change to the official interest rate of 1.5% for 12 months now.

Australian Interest Rate April 2016-July 2017
[Click to open new window]

And expectations are that there will not be any change for the rest of the year.

It’s the economic equivalent of watching paint dry. You can’t scream excitedly about nothing happening. Though, as scientists know, the absence of evidence doesn’t indicate evidence of absence.

Nothing happening can be a big news story.

But for now…crickets!

What to expect for interest rates going forward

Which brings us to more long-term forecasts.

This is the where realm of fortune tellers and economists meet. But you can divide the opinion into two main groups.

The first and probably largest group of economists believe that the next move for interest rates is up. Though not until late next year.

Their thinking is that we are at record low interest rates. The main economic data, such as positive capital expenditure from businesses, good levels of employment and higher business confidence levels should flow through the economy over the next 12 months.

And if wage growth starts to move up from its record lows, this would add further support for this idea. More wages mean more spending. More spending means more profits, which mean more employment, and so on.

It sounds good when you put it like that.

But there is of course the contrarian position.

Could interest rates get even lower?

Well, they could. And if we look at the experience in Europe, maybe even a lot lower.

bond yield for European countries 06-09-17
Source: Zerohedge.com
[Click to open new window]

This table shows the two year bond yield for European countries. In other words, the interest rate you would receive if you were to lend one of these countries your money.

Now think about how weird this looks. Interest rates are actually negative in 19 countries. You actually have to pay them to hold your money!

This is unprecedented territory, and the ramifications in the long term are unknown.

But it does show that interest rates can go lower than you might think. Even below zero.

Can this this happen in Australia? Yes it can. Though it is probably unlikely. It would take a major economic shock to force us into this move.

The ramifications for the economy are immense.

And despite all the talk of government debt, it’s actually fairly low compared to a lot of developed nations. So we have some wiggle room in terms of government spending, which will likely flow into the economy before interest rates are moved lower.

It’s clear the RBA will not reduce interest rates again lightly. They know the main beneficiary at the moment seems to be housing prices and — bubble or not — this sector doesn’t need any more fuel.

Mortgage holders and savers need to act now while rates are low

The prudent course of action for mortgage holders right now is to pay down debt as fast as they can. If nothing major happens then an economic recovery will come along at some stage and interest rates will — eventually — revert to more normal levels.

And by more normal, I mean you could see mortgage rates back around 7–8%.

So building a buffer now makes sense.

For retirees and savers looking to build wealth or generate income, I’ve got some bad news for you. The central banks of the world don’t want to give you an easy ride.

The act of lowering interest rates is intended to shift you out of cosy term deposit so you can stimulate the economy.

Some reward for your prudence, I know.

This leaves you with some tough decisions on where to put your money.

Luckily our in-house income expert Matt Hibbard has come up with a very smart strategy to ‘piggyback’ on the success of the government’s own Future Fund.

As you might have read last week, this fund — headed by Peter Costello — is smashing its targets, and has generated an average return of 7.8% since 2006. That’s remarkable when you consider that the period includes the massive crashes of the 2007/08 GFC.

If you want to generate more income, you can read more about Matt’s strategy here.

Good investing,

Ryan Dinse,
Editor, Money Morning

Ryan Dinse

Ryan Dinse

Ryan Dinse is an editor at Money Morning. With an academic background in economics, he believes that the key to making good investments is investing appropriately at each stage of the economic cycle.

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