Interest Rates - on the way down
Posted: October 07, 2008
It was only two issues ago that we looked at the benefits some investors were reaping from higher interest rates. Now it appears that the Reserve Bank may have pressed a bit hard on the economic brakes and there is a broad expectation that interest rates are now on a downward trend.
Of course, any drop in interest rates is a welcome gift for anyone with a mortgage, though it remains to be seen if the banks and other lenders will pass on the full benefit on each occasion. The banks continue to argue their need to maintain (or restore) their margins while politicians and consumers exert pressure through the media to provide the full benefit of any interest
rate relief.
As local interest rates start to fall, the returns from cash management accounts, term deposits and other interest bearing accounts will also decline. This will encourage investors once again to start looking for alternative investments offering more attractive yields.
The Australian share market has fallen by around 25% from its high point in November 2007. Some of the larger banks have been sold down even further on the back of credit market losses. Both NAB and ANZ are 40% below their high points. Even so, the big banks are generally expected to at least maintain their dividends in coming years.
Taking franking credits into account, there are an increasing number of shares offering dividend yields of nearly 10% in the current market. Of course, shares are not without their risks, but there’s a good chance that we are near the bottom of this cycle. Besides, declining interest rates are usually good for share prices, so apart from the great yield, buying now offers investors good prospects for capital growth over time.
The listed property sector is also offering high yields at present. While some property companies are struggling to survive as they restructure their affairs and reduce their debt, there are others in the sector that don’t have the same debt burden. They continue to pay regular distributions, but their prices have fallen considerably. As a result, there are some very attractive yields on offer. The challenge with the property sector at present is sorting the wheat from the chaff, so careful research is required.
Although there is a broad consensus that interest rates will continue to fall, it’s worth remembering how quickly the economic outlook can change. Just a month or two ago there was talk of further rate rises. Oil was increasing in price and the Aussie dollar was nudging parity with the greenback. It’s a very different story today, and the RBA has switched its focus from controlling inflation to maintaining growth.
The future will always hold surprises, but with declining business confidence, lower consumer spending and easing house prices, it’s a fair bet that we’ll see further rate cuts. And, in the order of things, the start of a recovery in the share and property markets should not be too far behind.
