0.75% and your portfolios
The most prominent news of the week was Tuesday’s decision by the Reserve Bank of Australia’s (RBA) Board decision to cut the official interest rate, the so-called ‘cash rate’, to 0.75 per cent. There may be further cuts to follow. By the end of the week, the major banks had informed customers mortgage interests rates would generally be cut by 0.15 per cent. The gap reflects a combination of market power of the banking sector and the effective disconnect between how banks actually fund loans and the notional price of money set by the RBA.
Consistent with the RBA mandate, the Board lowered rates “to support employment and income growth and to provide greater confidence that inflation will be consistent with the medium-term target.”
The body of the statement provide the clues or signposts that necessitated the decision, and these are the most important for your portfolio. Parsing the RBA statement, we assess the order of importance of the factors driving the decision were;
- Interest rates are very low around the world and further monetary easing is widely expected.
- Uncertainty regarding “the outlook for consumption, with the sustained period of only modest increases in household disposable income continuing to weigh on consumer spending”
- “New dwelling activity has weakened and growth in housing credit remains low. Demand for credit by investors is subdued and credit conditions, especially for small and medium-sized businesses, remain tight”.
- Wages growth remains subdued and there is little upward pressure at present, with increased labour demand being met by more supply
The Cash Rate continues its post-GFC decline
What this means for your portfolios.
- At a high level, sustainable wealth in an economy is usually generated by a combination of higher productivity and the effective deployment of new capital. Enabling business, small and large to invest at higher levels to drive productivity is positive for the economy. Your portfolio benefits from this activity through holdings such as CML Group, the working capital financing company.
- We expect the impact of these rate cuts on disposable income and wages growth to be muted. The cuts will provide a small fillip for the housing market and consumer spending through spring and into Christmas, but in the case of retail spending it will be from a very low base of current growth. Your portfolio’s positions in radio advertising will benefit as business compete for the expectation of higher levels of demand.
- The degree to which further credit growth is stimulated by lower interest rates and recent isolated buoyancy in real estate will be the key to economic conditions over the next 18 months. At this stage the data is mixed, with no clear positive signs in new financing activity, and the opposite in new dwelling activity as noted by the RBA.
- Lower rates in Australia and more importantly the expectation of rates moving lower still, reduces upward pressure on the exchange rate and this benefits company's in the portfolio than generate significant profits in foreign currencies such as BHP, QBE and Cardno amongst others.
The mention of “further monetary easing” in the statement is especially interesting in an environment when rates are already around zero globally.
Over the coming weeks, we will continue with a discussion around the current interest rate environment and the implications it has for our investment process and your portfolio.
- Craig Shepherd