Investment Matters

Interest rates

What happened this week?

Australia's central bank, the RBA, met and decided (as expected) to leave the benchmark interest rate unchanged at 2.0%. 

RBA rate

Australia vs overseas

Although 2% is historically low in Australia, relative to most other developed countries, our benchmark interest rate is quite high.  The NZ rate is comparable.

Central bank

General thoughts

Markets do not see interest rates, on a global basis, increasing substantially over the next 10 years.  This is exhibited by the US 10-year bond rate, currently at 1.75%.  Such a low rate implies a fairly negative longer-term economic outlook.  More specifically, low rates are reflective of (on a global basis) adequate to excess economic capacity (with some significant over-capacities e.g. steel, noting Arrium entering voluntary administration yesterday) related to:

a. low inflation
b. benign economic growth rates, and
c. high levels of debt.

As mentioned above, Australia's cash rate is relatively high.   Concerns about Australia's economy should be tempered somewhat, because Australia's central bank retains the capacity to respond if economic conditions here do deteriorate.

As an aside

This week Westpac has become the second bank to come under ASIC action relating to the Bank Bill Swap Rate (BBSW).  ASIC contends that ANZ and Westpac manipulated the BBSW for their own benefit.

What is the BBSW you may ask?  'BBSW' is the bank bill swap rate, and is the interest rate at which banks trade bank bills of varying maturities.  It is set with input from a panel of banks (the big 4 plus 10 international banks) each morning at around 10am.  

As it is the rate at which banks trade bank bills it reflects the base interest cost for banks.  And so is most useful as a benchmark.   The BBSW is used as the base rate to define the floating interest rate (e.g. BBSW + X.X%) for many commercial and corporate loans.  It is also used for a variety of other loan / debt arrangements (such as hybrid interest payments).

BBSW reflects the cost of funds to a bank, part of which is the RBA's cash rate.  So movements in the RBA cash rate will affect BBSW. 

So BBSW is a benchmark, similar to the UK's LIBOR (London Interbank Offered Rate).  Huge fines (many billions) have been paid by banks overseas relating to the manipulation of this rate.