How long can interest rates remain on hold?
The official cash rate in Australia is at a generational low of 2.5%, and has remained at this rate for a year. We examine why rates may remain on hold for a little while longer, and what this means for investors searching for yield.
More work to be done to stimulate the economy
Rates have been reduced to help stimulate the economy. Lending rates on housing and business loans have decreased, and this has seen a pick-up in house prices, approvals to build new homes and some improvement in retail sales. However, the Australian dollar remains high, and with mining investment still falling, and some uncertainty about other parts of the economy, we believe it’s still too early to declare victory and begin raising rates. In fact, the Reserve Bank of Australia has flagged that low interest rates are likely to remain in place for a period ahead, which, in our view, could take us well into 2015.
Why has the Australian dollar remained high?
The official cash rate in Australia is at a generational low of 2.5%. While this is a low rate, it is a lot higher than the near-zero cash rates in the US, Europe and Japan. This is one reason why the Australian Dollar remains at elevated levels above estimates of its long-term fair value. Investors would prefer to move their cash to Australia to earn 2.5% interest rather than hold their cash in other countries and earn low or no interest. This creates demand for the Australian Dollar and has seen the currency remain elevated.
The effect of low rates on term deposits
So, what does this mean for term deposit holders? Well, they’re likely to remain low for some time to come, and may even fall further. As a result of low rates, we’re likely to see the search for more attractive income or ‘yield’ continue. Such conditions make life difficult for those investors who have a fixed rate of return in mind, particularly those with term deposits and other cash-like investments which form a core part of their investment strategy.
Where can investors go in the search for yield?
Corporate bonds, infrastructure and property all have comparatively higher yield than term deposits and can be a good source of income. In addition, Australian shares have also been a great provider of income. In Australia, we’re fortunate in that we have high dividend payout ratios for corporates, and the franking credit system encourages the payment of decent dividends. Dividends are great for investors as they provide a relatively stable and attractive source of income, and can provide a degree of security in uncertain and volatile times.
Article courtesy of Dr Shane Oliver, AMP Capital.