RBA rate cut – the good, the bad and the greedy

This week’s 50 basis point interest rate cut by the RBA to 3.75% was undoubtedly well received across much of the nation. With a subdued global economy taking its toll domestically, and the inflation rate falling below the RBA’s 2 to 3 per cent target range, a cut was widely anticipated... though the magnitude of it both surprised and pleased many.

Naturally, it didn’t take long for Federal Treasurer Wayne Swan to appear on television, taking credit for the cut and the economic boost it will undoubtedly provide. He described it as a win for everyday Australians, citing the benefits for households and small businesses specifically. Markets cheered the news, and mortgage holders, borrowers, consumer driven businesses and Labor politicians will no doubt be elated.

But what of those Australians for whom things just got a little tougher? And I’m not referring to Tony Abbott, who was quick to rain on the parade by suggesting that this rate cut is an indication of economic weakness. And he may well be right; but no doubt had this cut taken place under an Abbott government, he would be touting it as a personal triumph, just as the Treasurer did.

And before you suggest political bias on my part, I am impartial in my criticism. The Treasurer taking credit was equally absurd. I find it comical how politicians take credit for things that are largely out of their control. Mr Swan comparing interest rates now to when the Coalition left office in 2007 is meaningless. Something called the global financial crisis took hold of the world’s economy as the Coalition left office, and so falling interest rates were inevitable, irrespective of which party was in power. And had the Gillard government been in power over the course of the four years prior to 2007, it too would have overseen a rising interest rate environment.

But I’m getting off topic. The Australians I’m referring to who are worse off now are pensioners. Pensioners living off their retirement savings will see a reduction in their income on the back of this rate cut. And being naturally cautious in their investment approach, many pensioners rely on such savings in banks and building societies for their income.

National Australia Bank (NAB), the day after the rate cut, announced a 50 basis point cut in term deposit rates despite only passing on 32 basis points to mortgage and small business loan holders... a bit cheeky for a bank that has been trying to distance itself from the practices of the other three big banks! So while things have improved for those struggling with mortgages, the benefit to them is outweighed by the income reduction to depositors. Commonwealth Bank of Australia (CBA) delivered a 40 basis point reduction in its interest rate on variable home loans, while Australia and New Zealand Banking Group (ANZ) and Westpac Banking Corp (WBC) have yet to move.

As an aside, the banks have already, as has been the case historically, received strong criticism on account of their withholding a chunk of the latest rate cut. The Treasurer duly lashed out at them as greedy, saying it’s “an insult to hard-working Australians”. But isn’t it naive to expect publicly listed companies, whose mandate is to work for shareholders and increase profits, to do anything but? Don’t get me wrong, it can leave a bad taste in your mouth, particularly when savers get slugged with the whole rate cut, but it can’t really come as a surprise now, can it?! The banks will attempt to balance the interests of home loan borrowers and shareholders, but shareholders will always win.

Getting back to pensioners, they now find themselves in the situation whereby they are obliged to seek out risk assets in order to supplement income lost through falling interest rates.  And as cautious investors, this puts them in a difficult situation, as most will feel out of their depth in their quest to find appropriate investments. The last time the RBA official cash rate was this low was in December 2009, when the GFC was wreaking havoc. But prior to the GFC, we haven’t seen rates this low in at least two decades; and at this level, many pensioners will need to do more than just have cash on deposit if they are to get by.

Lower interest rates are traditionally good for equity markets, for obvious reasons. Although existing investments in bond funds will rise as interest rates fall and the face value of older bond issues rise, new cash and fixed interest investments offer soft returns in a low interest rate environment, meaning capital inevitably gets diverted to risk assets such as equities. We can expect to see a large switch from money market and fixed interest funds into high yield equities specifically, as replacements for a dwindling cash rate are sought. Stocks like Telstra (TLS), yielding 7.8% fully franked at the current price, becomes much more attractive in the current interest rate environment, where term deposits offer roughly 5% with no tax credits.

We have developed a number of strategies and portfolios to enable members to eke out consistent returns that significantly outperform term deposits. The Rivkin Income Portfolio currently yields an average of 9.8%, approximately double the average term deposit rate on offer now. The Rivkin Blue Chip Portfolios (we release one per quarter) also offer solid yield (April portfolio yields 8.6%), with exposure to capital gains also, which is, if anything, to be expected as capital flows in to equity markets. And these yields are particularly beneficial to Rivkin Super members, with the tax credits on offer being treated preferentially inside superannuation funds (including self-managed).

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