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RBA cuts official cash rate

The Reserve Bank of Australia (RBA) cut the official cash interest rate by 0.25% to 2.25 % at February’s meeting. This decision was largely priced in by interest rate markets. In this article, we look at the key implications for SMSF investors.


The Reserve Bank of Australia (RBA) cut the official cash interest rate by 0.25% to 2.25 % at February’s meeting. This decision was largely priced in by interest rate markets. In this article, we look at the key implications for SMSF investors.
 
Interest rates and the economy
There are good reasons for the RBA to be cutting rates further:

  • Growth is too low, running at around 2.75% through last year, which is well below potential (of around 3-3.25%) and the level needed to prevent a rise in unemployment.
  • Confidence is subdued, having well and truly given up the post 2013 Federal election boost. Partly reflecting this, consumers have started to become more focused on paying down debt again, which is a sign of increasing caution and will threaten spending if sustained.
  • Prices for iron ore and energy have collapsed resulting in a bigger hit to national income than expected a year ago.
  • Outside the US the predominant trend globally is still towards monetary easing and this is putting pressure on the RBA. Massive quantitative easing programs in Europe and Japan are forcing smaller countries to ease unless they want to see their currencies go higher. It's worth noting that interest rates in Australia are still high on a global basis and this attracts global investors to the Australian dollar, keeping it higher than it should be.
  • Benign inflation provides flexibility for the RBA.
 
Will rates go down again?
The main risk in cutting rates again is that it further inflates the residential property market. However, strong property price gains are largely concentrated in Sydney and the RBA sees this as more of an issue for the prudential regulator, APRA (Australian Prudential Regulation Authority). Overall, we see the RBA’s cut as justified and, given that there is rarely just one move, we expect another 0.25% cut taking the cash rate to 2% in the months ahead.
 
4 things for SMSF investors to consider

  1. Bank term deposit rates
Deposit rates are becoming even less attractive and will remain low at least into next year. As a result, there is an ongoing need to consider alternative sources of yield and return.
 

  1. Remain cautious on the Australian dollar 
Even though the Australian dollar is nearly back to the US$0.75 level (that marks fair value on the basis of relative prices), past experience tells us that it can overshoot. It’s important to note that the Australian dollar hasn’t fallen nearly as much against the euro and yen putting more pressure on for further weakness against the US dollar. The RBA has indicated that a lower exchange rate will likely be needed, and so it is likely to ease further until it achieves this. In the short-term, the Australian dollar is oversold and could bounce - but we expect a fall to US$0.70 by year end. As such, we continue to favour unhedged over hedged global shares.
 

  1. Overweight Australian versus global bonds
While Australian bond yields are low, they are still high by global standards and are likely to provide better returns than global bonds. This is because the global search for yield is resulting in an ongoing convergence of Australian bond yields on much lower global bond yields. The lower rates seen globally coupled with further RBA easing, are pulling down local bond yields resulting in stronger capital growth from Australian bonds. This should serve to benefit Australian corporate debt relative to global corporate debt.
 

  1. Yield bearing growth assets remain attractive
With low interest rates, growth assets providing decent yields will remain attractive. This includes commercial property and infrastructure but also Australian shares which continue to offer much higher income yields relative to bank term deposits.
Final thoughts
Overall, we see Australian growth picking up gradually as the year progresses to a 3-3.5% pace through next year, but the RBA’s latest rate cut and one more to come provide confidence that this will occur.

 
About the Author
Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist at AMP Capital is responsible for AMP Capital's diversified investment funds. He also provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets.


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