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Will rate cuts push up share values?

For many economists it's a question of 'when' not 'if' interest rates start to fall. But how can investors prepare?
By · 4 Mar 2024
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4 Mar 2024 · 5 min read
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It’s remarkable that while consumers have battled a cost-of-living crunch, we’ve still been able to tuck away considerable cash savings.

Australians are collectively sitting on $1,455 trillion in cash deposits – about half the value of total deposits held in our banking system.

Plenty of people have undoubtedly ramped up their cash savings to take advantage of some of the highest rates on deposits seen in over 10 years. But is the tide about to turn?

Economists expect rates to head south

A number of banks are predicting rates to fall this year.

The Commonwealth Bank, which holds more than one in every four dollars that Australian consumers have on deposit, is expecting rates to start heading south from September.   

NAB believes rates will stay on hold until November, after which it’s forecasting rates to fall. Over at Bendigo Bank, economists think we may have to wait until early 2025 before rate cuts are announced.

Of course, these are all predictions. Nothing is set in stone. But it’s fair to say a backflip in interest rates won’t be welcomed by everyone.

Right now, savings accounts offer a government-guaranteed opportunity to earn returns that can top 5%. It’s great for anyone looking for a very low-risk way to save for a major goal such as first home buyers, and those who rely on interest earnings for additional income.

It’s worth bearing in mind though that if the Reserve Bank of Australia (RBA) starts to cut rates it will likely be because inflation has fallen to an acceptable level. So, our money should buy more, which is a plus for household budgets.

However, in the world of money, few things happen in isolation, and cuts to the cash rate may trigger other events.

Will lower rates push up share values?

In theory, a fall in interest rates should drive up share values as investors seeking higher returns move money out of cash and into equities.

In reality, it’s not as simple as ‘lower rates = higher share values’.

Since February 2023, for example, the RBA has hiked rates five times. Yet Aussie shares have gained 3.20%, and delivered total returns, including dividends, of 7.94%.

It goes to show that investment markets don’t always behave in the way that textbooks suggest.

The other thing is that with rate cuts being widely expected, any RBA announcements to this effect are unlikely to produce wild climbs in share values.

For me, the bigger picture is that shares are a long-term investment, and over periods of five to seven years, shares have historically outperformed savings accounts anyway, and there’s no reason to think they won’t in the future.

Even so, it makes sense to think about how lower rates could impact your portfolio, especially if interest earnings are a major source of income.

Part of that process should involve a close look at the return you are actually earning on cash savings. An investigation by consumer watchdog, the ACCC, found savings accounts aren’t always as rewarding as they seem.

Banks may offer attractive bonus rates but savers often need to meet strict, and in some cases, complex, conditions to continually earn the top rate. Many people simply can’t keep up with those conditions. The ACCC found that in the first half of last year, around 70% of bonus interest accounts did not pay bonus interest at all on average in a given month.

Other savings accounts offer decent rates but only for a short introductory period. Or you need to be a certain age, or hold savings up to a specific value, to earn the highest advertised rate.

It can all become very complicated, which is ironic given that savings accounts have traditionally been one of the most straightforward investments around.

The upshot is that the prospect of falling rates can make shares, and exchange-traded funds (ETFs) that invest in stocks, more attractive as long as you’re prepared to accept increased risk and ongoing volatility.

If you prefer to stick with cash in the bank, that’s fine. Just keep an eye on the rate your money is earning. It’s a fair bet the return isn’t as high as you think, and it could fall further if rates start to come down.

 

 

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Paul Clitheroe
Paul Clitheroe
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