October 6, 2014 taxitime

Could Interest Rates Fall Further?

Australia already has record-low interest rates – but in a recent speech, Governor Glenn Stevens noted that there is still scope for further rate cuts. So could rates fall further? And why have they stayed so low for so long

Australian borrowers have been enjoying record low interest rates over recent years. But for investors looking for a higher return on cash, reports that rates will stay low, or could even fall further, is unlikely to be welcome news.

While the Reserve Bank (RBA) is keeping its options open, it remains largely optimistic that further rate cuts will be unnecessary. In fact, analysis from the Commonwealth Bank economics team forecasts an increase in the cash rate to 2.75% around February 2015.1

Nevertheless, interest rates remain at historic lows and are looking to stay that way for some time. The question is why?

The impact of low rates on the Australian economy

Raising and lowering interest rates is the most powerful tool the RBA has to regulate economic activity. Lowering interest rates helps to stimulate growth, as it becomes easier for consumers to borrow for housing and investment. This encourages people to withdraw their money from savings accounts in the bank and invest it in other ways.

The low rate environment of recent years has had the intended effect on the economy, as more Australians have invested into assets offering higher returns, such as shares and property.

As a result, asset prices have risen and the demand for credit has strengthened, along with spending and housing construction. While building approvals dropped earlier this year, they picked up by 4% in May2 – suggesting a steady demand for housing due to low interest rates.

In addition, GDP increased at an annualised pace of around 3% in the second half of last year, up from just under 2.5% in the first half. That's an encouraging sign that economic growth is returning to something like the long-term historical trend.3

Looking ahead

On the other hand, the economy still faces some challenges. The last quarter saw a small decline of 0.5% in retail trade4 following a fall in consumer confidence. What’s more, the pace of spending growth across the economy has continued to slow for six of the past seven months5. And while July's unexpected jump in the unemployment rate to 6.4% may partly be the result of statistical noise, weak jobs numbers are another reason to keep rates steady6.

Another important challenge for the economy is the strength of the Australian dollar, which has been driven up by overseas investors taking advantage of high interest rates and buying up Australian currency. This level of competition puts Australian manufacturers and exporters at a disadvantage – one reason why RBA Governor Glenn Stevens is reluctant to raise interest rates in the near future.

However, Stevens also expresses optimism, maintaining the likelihood of a significant fall in the Australian dollar at some point.

In terms of lowering rates further, Stevens acknowledges that the RBA retains the "ammunition" to make further cuts to interest rates if required. But he anticipates that rates "might be on the brink of sitting still for some time"7 as the economy morphs from the largest mining investment boom in Australian history.

Making the most of your investments

For self-funded retirees and others seeking to generate income from their investments, the prolonged low-interest rate environment presents an ongoing challenge.

The good news is that there are alternatives that can deliver a secure and stable income – from Australian and overseas fixed interest investments to high-yield shares. Talk to your Financial Adviser about investment opportunities that may suit your personal situation.

Sources:
1 Global Markets Research. Economics: Update. 8 August 2014
2 Global Markets Research. Economics: Perspective. 27 June 2014
3 Stevens, Glenn. Economic Update. 3 July 2014. http://www.rba.gov.au/speeches/2014/sp-gov-030714.html
4 Australian Bureau of Statistics, Retail Trade, May 2014
5 Business Sales Indicator, Commonwealth Bank June 2014
6 Global Markets Research. Economics: Update. 7 August 2014
7 Stevens, Glenn. Economic Update. 3 July 2014. http://www.rba.gov.au/speeches/2014/sp-gov-030714.html

Source: Colonial First State Investments

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