Viewpoint: The effect of cut price interest rates

By Renato Mota, General Manager Distribution

Last week the Reserve Bank of Australia decided to cut the official cash rate, stating that global growth is forecast to be low for some time. Clients who have mortgages are rejoicing about the news, hoping that their bank will pass on the cut. What about retirees or people who have low earning term deposits? How can you as a financial adviser take advantage of this for your clients?

With the recent RBA rate cut, mortgage holders are dreaming of having a bit more cash coming up to Christmas and retailers are looking forward to people spending that cash in their stores. But there are segments of your client base who may be disadvantaged by such low interest rates.

Retired clients

This low interest rate environment has been pretty tough on your average self-funded retiree client. They often blame the rate cuts for eating away at their retirement saving returns. Unfortunately it is unlikely that interest rates are going to increase dramatically very soon, but the good news is that this does provide an opportunity for advisers to re-engage with their clients around income needs. It also reinforces the importance of managing inflation risk – which if high, can destroy wealth in real terms in a low interest rate environment.

Investors have been hoarding cash for some time but according to a recent article in the Australian Financial Review¹ investors are asked to shun low-earing term deposits for investments with higher risk / return characteristics, such as shares and new housing. This message came out last month, but with rates now even lower it would seem even more pressing.

How low can interest rates go?

Many experts are speculating that interest rates are as low as they will go. Rates are now as low as they were in 2008 at the height of the GFC when businesses such as Lehman Brothers were collapsing. The risk is that if the RBA reduces the interest rates any more, millions of Australians will find themselves earning negative real rates of return, which unless they seek financial advice, will see the erosion of their retirement savings in real terms.

The challenge for our decision makers is the current effectiveness of monetary policy to stimulate the economy. With banks using the rate cuts as a means to manage their own interest margins and consumers using them as a means to reduce leverage, it begs the question of how effective they are in stimulating the economy.  

What we are facing is a crisis of confidence and there does not seem to be a catalyst to correct this. Thankfully time tends to heal all wounds.

Onto the next year

I would like to take this opportunity to thank you for your ongoing support over the last year. It has been a year of significant change for the industry and here at IOOF we have remained on our path of continuous improvement based upon your feedback, launching a number of significant initiatives such as IOOF AdviserConnect and changes to IOOF Pursuit.

Next year promises to be just as busy with continued industry regulations and worldwide economic changes. I hope that between now and then you are able to have a safe and happy holiday season!

Regards,

Renato

¹ Source: Upgrade to shares, RBA tells savers, Australian Financial Review, http://www.afr.com/p/national/economy/upgrade_to_shares_rba_tells_savers_PcuN1r6AX1ykEOLM1nYmRI