Calm Before the Storm

Wednesday, September 17, 2014

We remain in a time of historically low interest rates around the globe but this scenario can’t remain for ever. At a recent conference in Sydney we were shown a term deposit rate chart for the “Platinum Clients” of the Bank of America and these investors were being offered between 0.1%-0.2% to invest. It is no wonder that the US sharemarket has reached record levels when these term deposit rates are the alternative.

It is not only in the US where interest rates are near zero, Japan has had very low rates for a long time and rates in Europe are not too dissimilar. You may remember that not that long ago the front page news contained nothing but stories of European countries facing significant debt problems. We had numerous countries such as Greece, Spain, Portugal, Italy and Ireland just to name a few that were on the brink of going broke. There is almost an eerie silence now in terms of mainstream news about this problem that still exists. It may well be that in this low interest rate environment the servicing of these very large debts is affordable and as a result we don’t hear of it at the moment. What happens however when interest rates inevitably increase again? The obvious implication is that the cost for these countries to continue to service their debts increases and the front pages of the newspapers will tell us all about it again. Here in Australia our rates are well above zero but are still historically low and are possibly creating problems that we will face in the future, particularly with our housing market. The Reserve Bank is in no rush to hike interest rates despite its concerns about rising house prices. The central bank made particular mention of soaring capital city prices at their latest monthly meeting, deciding the risks associated warranted "close observation". "Additional speculative demand could amplify the property price cycle and increase the potential for property prices to fall later," the RBA said in the minutes of the meeting. Such a fall in prices could spark a bout of caution among households, and cause a slump in consumer spending” the bank said. But the minutes reiterated the RBA's stance that it won't be changing the cash rate any time soon. It is widely expected that a rise will not come until mid-2015, almost two years since its last move, which was a cut of a quarter of a percentage point to 2.5 per cent in August 2013. This delaying of interest rate rises may be detrimental according to some, including Queensland University of Technology financial economist David Willis who said the RBA must increase the cash rate in October or November. "Leaving rates on hold through the Summer will allow the housing market to potentially enter into a full boom, which would need significant monetary policy change to bring it from the boil," he said. "I think the RBA will realise they need to act before it's too late." Dr Willis said it was also important to lift the cash rate to reduce inflationary pressure as the Australian dollar falls below 90 US cents. A lower exchange rate would deliver a potential spike in inflation as the cost of imported goods rises, Mr Willis said, and higher interest rates would allow the economy a smoother adjustment. The RBA minutes indicated the central bank was more confident about the economy and an improvement in non-mining investment in the coming quarters. Low interest rates continue to support the economy and encouraged more risk-taking investment, the bank added. "Investors continued to look for higher returns in response to low rates on safe instruments and were accepting more risk in doing so," the bank said. It’s going to prove to be a balancing act for those in control of interest rate policy and while we may have up to 12 months of plain sailing ahead it may be an opportune time to speak with a financial adviser to ensure that your investments are in order to weather any storm that may arise.