INSIDE INVESTOR: Where to for Australian interest rates?

As debate continues about whether the Reserve Bank will cut further, hold steady or begin lifting rates, ripples are being felt in the stock market.

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You could argue that central banks play a pivotal role in how investors allocate their cash to a portfolio.

How much they put into bonds or other fixed interest investments like term deposits, how much they allocate to shares or property, or even gold.

These are all decisions that investors make, based on how they see the future and where they will get the best returns.

Let’s just take a look at recent history.

When the first stage of the financial crisis gripped the global economy, investors dumped their shares and headed for safety.

Traditionally, that usually has been found in US government bonds. Because everyone wanted bonds, the yields dropped sharply.

Ordinarily, those naturally lower interest rates would have been enough to kickstart an economic revival.

But so dire was America’s economic problems, the US central bank – the Federal Reserve – decided to pull out the big guns.

It engaged in three rounds of money printing, pushing down the value of the US dollar and sending interest rates to record lows. Less than zero if you take inflation into account.

What do you do as an investor in that situation? You take your money out of interest bearing deposits because you are going backwards.

And as that weaker greenback boosted company profits, stocks became more attractive. So the great Wall Street revival began in 2009 and hasn’t stopped, even though the US economy is still struggling.

We’ve seen a similar situation right here at home.

About 18 months ago, the Reserve Bank decided to start cutting interest rates in an effort to lift the struggling non-resource section of the Australian economy.

Many companies have been hit hard by the strength of the Aussie dollar which refuses to drop even though commodity prices have fallen. Partly, that’s because every other country is pushing their currency lower. So ours stays strong.

But for investors, that shift to lower interest rates encouraged a shift in their portfolios.

Suddenly the yields on stocks were so much more attractive than the return on safe investments like term deposits, that investors decided the extra risk was worth it. They plunged into shares and the stock market surged.

Right now there is a furious debate among economists about whether the Reserve Bank will cut further, hold steady or begin lifting rates.

But large parts of our economy are weak, and the resources engine is slowing. So don’t expect a rise any time too soon.

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