RBA cuts the cash rate to a record low

RateSetter recently featured on the Today Show’s ‘Money in the bank is going backwards.’ Why? It’s all to do with the cash rate, and how RateSetter offers investors a way forward.

Commentators have been foreshadowing a potential economic slowdown in Australia for some time (see here, here or here). On Tuesday, 4 June, the Reserve Bank of Australia cut the cash rate to 1.25 percent: the lowest cash rate on record.

Here, finance expert, Effie Zahos, discusses alternatives savers could consider to grow their funds in a low rate world.

So, what does a rate cut mean for investors?

Returns on traditional investments are likely to fall

The incumbent cash rate of 1.50 per cent is already low enough that many investors, including self-funded retirees with interest-bearing investments, are struggling to achieve returns that outpace inflation (currently 1.3 per cent). This will only become more difficult if the cash rate falls further.

Bonds

Of particular concern is the effect that a cash rate of 1.25 per cent could have on investment portfolios structured around bond yields, especially government bonds. Historically, such yields have tracked with the cash rate, which, at 1.5 per cent, has already resulted in government bonds yielding only two to three percent per annum.

Cash deposits

New cash deposits, including long-term deposits, are also likely to decrease in value for investors. For example, should the average three-month term deposit rate (currently 2.51 percent per annum) fall to reflect the cash rate, more than half of an investor’s anticipated returns will be consumed by inflation.

Shares

A low cash rate can have complex effects on share portfolios, with some sectors more likely to vary than others. For example, when the cash rate drops, companies in the finance sector often see their revenue decline because they have to lower their own lending rates. On the other hand, it can also lead indirectly to higher levels of disposable income, with increased consumer spending a boon for companies in the retail and technology industries.

This information does not constitute financial advice and you should consider whether it is appropriate to your circumstances before you act in reliance on it. Any opinions, forecasts or recommendations reflect the judgement and assumptions of RateSetter as at the date of publication and may later change without notice.