Australia’s central bank, the Reserve Bank of Australia (RBA), has three main objectives:
- Maintaining stability of the Australian dollar;
- Full employment; and
- The welfare and prosperity of Australians
The RBA and Federal Government believe that one of the best ways to achieve these objectives is to target the inflation rate (that is, the price of goods and services). A positive, stable inflation rate is associated with higher economic growth. However, the inflation rate has been lower than the target rate in recent years. The RBA is taking steps to see inflation rise, which should increase economic growth and assist in meeting the RBA’s three objectives.
One option for the RBA to generate inflation is to cut interest rates. The inflation rate was falling before the COVID-19 pandemic, and so the RBA cut interest rates three times in 2019. However, the pandemic has placed even greater downward pressure on inflation. The RBA response has included cutting cash rates to a record low of 0.1% as well as intervention in the bond market to buy Government Bonds and drive longer-term rates lower as well.
Along with the RBA, the Federal Government has also implemented measures to address the negative economic impact of the pandemic. These have included the JobKeeper and JobSeeker programmes, as well as personal and business tax relief in the Federal Budget.
Whilst Australia has been successful in containing the pandemic (including Victoria’s “second wave”) the negative economic impacts of the pandemic are expected to last for an extended period of time. In particular, the unemployment rate is anticipated to remain high for the next few years. Therefore, in their November meeting the RBA announced further measures to help achieve their three objectives.
Again, the interest rate was cut from 0.25% to 0.1%. The RBA also advised that it’s unlikely to raise the rate for at least three years. Other measures were also communicated with the purpose of encouraging economic growth and inflation including bond purchasing by the RBA to reduce longer-term bond rates. This will lower the cost of borrowing for State and Federal Governments, making it easier to finance their larger deficits during this period.
At the time of these announcements, the Governor of the RBA, Phillip Lowe, acknowledged the impact of low rates, particularly on those members of the community who rely on interest income from their investments.
There is a balance however, and whilst low rates do reduce the income received on investments, they lower the cost of borrowing for businesses making it cheaper for them to borrow and invest for the future. This should assist them to employ more staff and generate economic growth. The business incentives announced in the Government’s FY21 Budget (including accelerated depreciation) are also targeted at encouraging business spending and hiring new staff with the goal of supporting the economic recovery underway. Lastly, the latest rate cuts reduce the difference between our interest rates and other major economies. This makes our currency less attractive to speculators looking to profit from higher rates here relative to other countries and should, all else being equal, weaken the value of currency. This supports exporter earnings such as tourism by making it relatively cheaper to other countries
Phillip Lowe also acknowledged that whilst negative interest rates may have some benefits, including putting downward pressure on the Australia dollar (this would assist Australian exporters’ competitiveness), they are not helpful to the economy over the longer term. Therefore, he expected it was unlikely that interest rates would be cut any further.
What action should you take if seeking a higher income return from your investments?
Interest rates look set to remain extremely low for the foreseeable future (at least three years), with both local and global inflation very muted. Based on the RBA Governor’s statements, however, it does appear we may have reached a bottom in so far as he has stated that the RBA is unlikely to entertain negative interest rates. In such an environment, it will be difficult to generate a satisfactory level of income from those investments that only provide an income return, for example cash and term deposits.
In this case it is important to diversify your investment portfolio across a wide range of assets that include investments that not only generate higher levels of income but also capital growth. This capital growth can help grow an effective income stream over time.
This may include Australian and international shares – which can generate dividends along with franking credits (for Australian Shares), and property and infrastructure – which generate a yield from rents and other stable income streams. Whilst these investments can provide you with a greater income and overall return, compared to cash and term deposits, they do come with increased risk (or volatility). So, it’s important to balance your allocation to each of these investments with the level of risk you are comfortable with.
In this low interest rate environment, reach out to our office to determine the appropriate investments for your portfolio to ensure you can generate a sufficient return, taking into account it meets your tolerance for investment risk.
The information provided is general in nature. It has been prepared without taking into account any of your individual objectives, financial situation or needs. Before acting on this advice you should consider the appropriateness of the advice, having regard to your own objectives, financial situation and needs. This publication is prepared by IOOF for: Bridges Financial Services Pty Limited ABN 60 003 474 977 AFSL 240837, Consultum Financial Advisers Pty Ltd ABN 65 006 373 995 AFSL 230323, Elders Financial Planning ABN 48 007 997 186 AFSL 224645, Financial Services Partners Pty Ltd ABN 15 089 512 587 AFSL 237 590, Lonsdale Financial Group Ltd ABN 76 006 637 225 AFSL 246934, Millennium3 Financial Services Pty Ltd ABN 61 094 529 987 AFSL 244252, RI Advice Group Pty Ltd ABN 23 001 774 125 AFSL 238429, Shadforth Financial Group Ltd ABN 27 127 508 472 AFSL 318613 (‘Advice Licensees’). This publication is not available for distribution outside Australia and may not be passed on to any third person without the prior written consent of the Advice Licensees. The views expressed in this publication are solely those of the author; they are not reflective or indicative of the Advice Licensees position and are not to be attributed to the Advice Licensees. They cannot be reproduced in any form without the express written consent of the author.