You may have heard the terms ‘ultra-low’ and ‘lower for longer’ interest rates in the news over the past few months. Have you ever wondered why this is happening and how the low cash rate might impact on you as an investor?
Read on as we break down everything you need to know about the current economic environment.
The Reserve Bank of Australia and Monetary Policy
Firstly, it’s important to be aware of what the Reserve Bank of Australia (RBA) is and what it does.
The RBA is Australia’s central bank, and it is responsible for maintaining a strong performing financial system. The primary way the RBA achieves this is through monetary policy.
As part of its responsibility for Australia’s monetary policy, the RBA sets the cash rate for the interbank lending market – that is, where the Government, commercial banks, and other financial institutions can borrow or lend money among themselves in response to short-term fluctuations in their liquidity position and forecasts.
The cash rate that is announced each month (except January) is the interest rate financial institutions pay to borrow funds from other lending institutions in the cash market.
The RBA adjusts the ‘cash rate’ with the focus of controlling money supply and it influences and is influenced by economic conditions such as consumption, employment, inflation, and liquidity.
What’s happening in the current market?
Over the past few decades, there have been several events that have caused shocks to the financial system. The economic impacts of those events have been quite significant, as seen in the Global Financial Crisis, ‘Taper Tantrum’ in 2013, and more recently, COVID-19.
While COVID-19 was primarily a public health issue, the social measures introduced to mitigate the health crisis, such as lockdowns, caused a significant rise in unemployment, reduction in consumer spending, and ultimately a weaker Australian dollar.
To assist in minimising the impacts of a potential recession, the RBA reduced the cash rate twice in March 2020 from an initial 0.75% to 0.25%, and again in November to 0.1%. There was also a conscious coordination of Fiscal policy.
This proved to be an effective approach and, by the fourth quarter of the 2020 calendar year, broad signs of recovery were seen across multiple sectors.
The property market in particular, saw signs of recovery where demand had built over the prior six months due to cautious consumer sentiment. This demand has begun to flow through the economy and property prices have been the standout economic indicator for the 2021 calendar year to date.
A record low cash rate
Thirty years ago, in January 1990, the cash rate was at a high of 17.50%. The rate has been gradually falling ever since, with the last increase in the cash rate now over a decade ago where it was raised from 4.50% to 4.75% in November 2010.
To understand just how low the current cash rate is, let’s look back at historical cash rates.
The current cash rate, at 0.1%, is the lowest Australia has ever seen.
What does a having a low cash rate mean? How does this impact investors?
So, the cash rate was reduced, but what does this mean?
The cash rate essentially affects the cost of money. By lowering the cash rate, this lowers the interest required to be repaid on money borrowed by commercial banks in the cash market. This is then intended to encourage banks to lend more money out to consumer and institutions, thus stimulating the economy.
The cash rate influences almost every other interest rate across the economy as it is used as a reference rate for banks when setting their own interest rates to the public. While not always the case, the reduction in interest is often passed on to their borrowers and investors.
1. Economy stimulation
This has a stimulatory effect on the economy as lower cash rates generally mean you may pay less interest on money borrowed than when the cash rate is higher. This is why people might say ‘money has never been cheaper’.
The low cash rate also helps Australia’s trade-exposed industries through a lowered exchange rate, which means that our exports become more competitive in the global marketplace.
A lower cash rate also means growth assets are revalued higher due to the potential significant returns holding these assets can deliver above the ‘risk-free rate’. The risk-free rate is typically considered the Australian Government bond rate.
2. Returns on cash and fixed interest investments
While this positively affects borrowers, low interest rates typically also mean investors may find it harder to achieve competitive returns on their cash and investments that pay interest returns that are aligned with the cash rate.
How long can we expect the low cash rate?
According to the RBA, rates are likely to remain at these record lows for the next few years.
In their December announcement, the RBA’s Monetary Policy Governor, Philip Lowe, named the conditions under which it would consider raising rates again.
“The Board will not increase the cash rate until actual inflation is sustainably within the 2 to 3 per cent target range,” Mr Lowe said.
“For this to occur, wages growth will have to be materially higher than it is currently. This will require significant gains in employment and a return to a tight labour market.
“The Board does not expect these conditions to be met until 2024 at the earliest,” he said.
Navigating investing in the lower for longer interest rate world
The challenge for investors in this historically low interest rate environment is ‘the hunt for yield’ or finding investment options that provide competitive returns.
Investors with large proportions of cash in their portfolio may look to re-evaluate their investment strategies and move their cash holdings into alternative investments, such as equities or property. However, this often means also taking on a higher level of risk.
At Trilogy, we offer a range of alternative, professionally managed investment options. They each cater to different levels of risk and asset classes, and aim to provide competitive, risk-adjusted returns in this low-rate environment.
We offer a pooled mortgage trust, the Trilogy Monthly Income Trust, diversified income fund, the Trilogy Enhanced Income Fund, unlisted property trust, the Trilogy Industrial Property Trust and portfolio of fully subscribed, single-asset property trusts.
Within the fixed interest investment universe, our professional management and strategic allocation of assets means we are able to generate returns across different cycles and through different periods of changing market sentiment. This also allows us to balance our portfolio between securities – such as floating rate bank notes issued by major Australian banks or increasing our exposure at any time to a government debt strategy – to generate competitive, risk-adjusted returns.
Whatever you decide, it’s important you understand and are comfortable with the risk you’re taking on. It’s important to seek investment options that suit your personal circumstances, financial goals, and tolerance for risk. We always recommend seeking independent financial advice before making any investment decision.
This article is issued by Trilogy Funds Management Limited ACN 080 383 679 AFSL 261425 (Trilogy) as responsible entity for the management investment schemes mentioned in this article. Application for investment can only be made on the application form accompanying the relevant Product Disclosure Statement (PDS) available at www.trilogyfunds.com.au. The PDS contains full details of the terms and conditions of investment and should be read in full, particularly the risk section, prior to lodging any application or making a further investment. All investments, including those with Trilogy, involve risk which can lead to loss of part or all of your capital or diminished returns. Trilogy is licensed to provide only general financial product advice about its products and therefore recommends you seek personal advice on the suitability of this investment to your objectives, financial situation and needs from a licensed financial adviser. Investments with Trilogy are not bank deposits and are not government guaranteed.