Finance Finance News Five ways a rate cut could hurt us all

Five ways a rate cut could hurt us all

A rate cut could do damage. Photo:Getty
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When the Reserve Bank of Australia board meets in Sydney on Tuesday morning to set official interest rates, outgoing Governor Glenn Stevens will be faced with plenty of conflicting pressures.

A cut in the RBA cash rate from the current record low of 1.75 per cent to 1.50 per cent would make some people happy. They would likely be those paying off mortgages and other debt.

It might also help the unemployed as money gets cheaper, tempting business and consumers to spend more, creating profits and jobs.

But there are lots of negatives to further falls in interest rates, particularly from these low levels.

Savers and retirees

If you’re trying to build a nest egg to buy a property or meet some other goal, then the low rate environment is not good news for you. Term deposit rates have fallen an average of around 2.85 per cent or less for money locked away for a year, according to research website Canstar.

For savings accounts the figures are even lower, somewhere between 1.5 per cent and 2 per cent if you take out promotional periods. If the cash rate is cut again, expect to see 0.25 percentage points come off those figures.

For superannuants, things are tough also. Lower interest rates cut super returns as the typical balanced fund is about 20 per cent invested in bonds and cash.

In the year to June, average super returns were a miserly 2.3 per cent, according to researcher SuperRatings, compared to an average of 7.8 per cent over five years. That’s not all due to falling interest rates, as stock markets were weak over the year, but rates are a significant influence.

It gets worse as people retire and move their super into more conservative allocations more exposed to bonds and cash. With the retiree investments weighted 37.7 per cent in conservative options compared to 13 per cent for those still working, lower interest rates are hitting retirement incomes much harder.

With the lower interest rate environment likely to last, professional investors are factoring in lower cash and bond returns into the future as this table from researchers Rice Warner shows.

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RBA has shot off all its ammo

RBA cannons are silent. Photo: Getty
RBA cannons are silent. Photo: Getty

When Australia went into the global financial crisis in 2008, the RBA cash rate was sitting at 8 per cent. That gave it plenty of firepower to cut rates dramatically as GFC threats loomed large.

Now with rates so low, IFM Investors chief economist Alex Joiner said he was “not convinced” that further cuts will help the economy. “And there’s no other policy lever to pull,” he said.

So cutting again now would leave little in the tank to fight future shocks.

Household debt boom

House prices have rocketed, particularly in Melbourne and Sydney, over the past 12 months and “that has been supported by the latest round of interest rate cuts”, Mr Joiner said.

“That’s a problem for the future as it’s pushing up Australian household debt which is already among the highest in the world relative to GDP,” he said. When interest rates rise, household budgets will be further squeezed.

Financial stress, flat wages and the lure of low rates are encouraging households to draw down on their home equity to pay bills. The latest ME Household Financial Comfort Report showed those in this category rising four points to 11 per cent from six months earlier.

The ‘Dread Effect’

miserly consumer confidence
Rate cuts are supposed to get us spending, but the pessimsim they arouse can have the opposite effect. Photo: Getty

As interest rates fall and economies remain sluggish despite government spending and money printing, consumers feel that something nasty could be round the corner and thus are reluctant to spend.

With prices falling in some areas, independent economist Saul Eslake told The New Daily people are prone to “deflationary expectations”.

“They are reluctant to spend because prices might be lower in the future.”

Banks and the dollar

Normally a cut in interest rates would push down the Aussie dollar. But with rates so low “the experience of the last year ought to tell the market the RBA has had little effect on the currency”, Mr Eslake said.

Further falls in rates could also squeeze bank profits, which could make normal lending unprofitable and encourage the banks to indulge in risky behaviour to boost margins that could ultimately damage the economy.

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