The Reserve Bank of Australia (RBA) cut interest rates this week from 3.25% to 3%. Interest rates have not been this low since Oct 2009 and many economists are now forecasting that rates could get as low as 2% in 2013. If that happens, it will be the lowest rate since 1960’s.
While this is good news for those with mortgages, its bad news for retirees and savers.
Now you may think from an economic perspective, that low interest rates are good news. Unfortunately, the RBA’s action of cutting rates, reflects their considerable concern regarding the state of the Australian and global economy.
RBA Governor, Glenn Stevens, said in his statement, dated 4 Dec 2012:
“Global growth is forecast to be a little below average for a time. Risks to the outlook are still seen to be on the downside, largely as a result of the situation in Europe, though the uncertainty over the course of US fiscal policy is also weighing on sentiment at present. Recent data suggest that the US economy is recording moderate growth and that growth in China has stabilised. Around Asia generally, growth has been dampened by the more moderate Chinese expansion and the weakness in Europe.”
“In Australia, most indicators … suggest that growth has been running close to trend over the past year, led by very large increases in capital spending in the resources sector, while some other sectors have experienced weaker conditions. Looking ahead, recent data confirm that the peak in resource investment is approaching. As it does, there will be more scope for some other areas of demand to strengthen.”
“Private consumption spending is expected to grow, but a return to the very strong growth of some years ago is unlikely. Available information suggests that the near-term outlook for non-residential building investment, and investment generally outside the resources sector, remains relatively subdued. Public spending is forecast to be constrained.”
High A$ A Concern
The other major concern for the RBA is the rise of the Aussie$, especially against the Greenback (US$).
A strong A$ has some negative effects:
In summary, a rising A$ costs Australian jobs and slows our economic growth.
So what does a slowing Australian economy mean to you?
Unfortunately, there is a threat that the economy will slow down so much that we go into deflation. Most people in this generation don’t know what ‘deflation’ means in an economic sense. So please let me explain …. You know that ‘inflation’ means the cost of goods and services go up – the value of real money decreases. So, deflation is the opposite of inflation which means a decline in prices and wages – the value of real money increases.
Why does deflation happen?
Deflation often happens as a result of a decrease in spending by governments, individuals and investors or a reduction in the supply of money or credit.
Why are economists and central bankers so concerned about deflation?
They are fearful of ‘deflation’ because it can lead to a downward spiral where prices and wages continue to decrease resulting in lower production and lower demand – this in turn pushes down prices and wages even further. Ultimately, this causes higher unemployment.
What does this mean for stock prices?
The value of stocks is impacted by the level of interest rates. Low interest rates are generally good for stock investors. In fact, it is common for the share market to rise as interest rates decline because:
Investors, looking for the best bang for their buck, compare the different types of investment vehicles (cash, property, stocks) against each other. As they see cash rates declining, the dividends from stocks and rental from property become more appealing alternatives to leaving their money in the bank. Business profits usually rise as their cost of borrowing declines. Investors are prepared to buy stocks on the expectation that earnings will grow.
At Wealthwise Education, we teach investors to focus on healthy businesses generating high dividends, offering franking credits and consistent earnings growth. We show investors how to find companies with attributes that will outperform for the long term.
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