Musing on Interest Rates


Australia’s cash interest rates are currently at record low levels. If your cash account earns that interest rate of 2.5% then you are probably just keeping ahead of official inflation rates – currently noted as 2.4%. If you are paying tax then that means your purchasing power is slowly being eroded. In other words, the ‘real rate of return’ after inflation is and tax is negative. Not so good for the nation’s savers.

On the other hand, borrowers are currently enjoying particularly low interest rates on their home loans. It seems that there is a winner for every loser in the interest rate world.

This post is a musing on interest rates – but with a wider perspective than just what is on offer today. It is my not-so-humble opinion that interest rates will be the big discussion point in global finances for the next couple of years. And here’s why i think that way…

Interest Rates and the RBA

Here’s a look at the current Reserve Bank of Australia (“RBA”) cash rate and the cash rate after inflation. You can see that anyone with large pools of money in cash has seen a steady erosion of their income position over the past 20 years.

Reserve Bank of Australia cash rates chart August 2013

Up until the GFC, cash was at least paying some form of ‘real’, after inflation return.

Naturally, marketers the world over are being paid large lumps of money to come up with sound reasons why you should not have your money in cash. And it’s not really news that cash is not the route to boost your millions in any meaningful way.

Interest rates other than cash..

Even the more sophisticated investors – who generally play in the 90-day bank bill turf, have found their premium slowly eroding. A number of these investors have moved to listed hybrid issues by major banks in an attempt to gain a higher income but this article from one of Australia’s leading financial players – Chris Cuffe – highlights just how much that play has involved a higher risk with an ever reducing relative return.

20130819 cash vs 90 day bank bills aust

The base interest rate of cash isn’t really improved by moving to 90 day bills – unless you take on more risk, of course.

Term deposits are probably a better indicator – but term deposit interest rates have been heavily impacted by forces outside of the normal borrower/lender supply and demand equation. Most heavily, the need for Australian banks to boost their deposit levels to help meet the international banking requirements that are changing quite a bit over the coming years. Banks needed more retail term deposit money and they were prepared to pay for it. Hence, term deposit rates carried a premium that was higher than the historical average (read : it was gravy while it lasted but there’s every chance the gravy’s running out).

Retail interest rates

A lot of clients have been surprised in recent years at how they have been able to obtain better term deposit rates than those on offer through huge wholesale accounts – such as “wrap” accounts and superannuation funds. That has been a result of the banks’ need to attract retail deposits to meet the banking guidelines mentioned above (simply put – retail term deposits count 100% to reserves while wholesale term deposits in the hundreds of millions of dollars may not count at all in some cases).

Here are the RBA figures for retail interest rates on savings accounts, cash management accounts and term deposits.

20130819 retail cash and deposit rates Australia

An interesting comparison of interest rates over a longer term

It’s interesting to see that ‘bonus saver’ accounts are now competing with one year term deposits, and online savings accounts (on average) have lost a great deal of their competitiveness in recent times. (These figures are all from the publicly available RBA historical tables).

The next paragraph and chart are only of interest for the technically minded, and can be ignored by everyone else….

If we go all nerdy for just a moment and focus on the wholesale 1 year interest rate swaps then we can get an idea of the underlying extra return that a term deposit could offer over the past 20 years.

Australian cash rate vs 1 year swap rate August 2013

One year interest rate premiums over cash haven’t stopped lower rates hurting the returns available for savers.

It will be interesting to see how term deposit rates evolve against cash rates when the RBA starts to lift its official interest rate.

Housing loan interest rates

Those with piles of cash may be feeling the pinch right now – but those with piles of debt based on the housing loan interest rate, are enjoying pleasant times indeed. Just how pleasant? Well, here’s the RBA’s latest August update on housing loans and their relativity to the housing loan interest rate.

Reserve Bank of Australia home loan interest rates 2013

The “actual rate” being paid by the average borrower is pretty much as low as it’s been in the last 20 years.

The period post the Global Financial Crisis (the good ol’ “GFC”) has been a rather kind one for those with home loans in Australia.

Predicting Interest Rates

If you are a regular reader of this blog then you know my position on anything involving prediction – it’s just a guess. And it doesn’t matter if it’s the best researched, most authoritative prediction ever devised by a human mind – it’s still a guess, just a better informed guess. For anyone interested in a good read about predictability and its pitfalls, i’d highly recommend “The Signal and the Noise” by Nate Silver – it’s a brilliant expose on predictive ability in everything from the weather to the stock exchange to sport. So my suggestion is that we cannot predict anything with certainty. Remember that next time you hear anyone predicting the interest rate direction – and that includes me!

Is Australia the tail on the dog?

Australia’s interest rates are undoubtedly decided in part by our local economic and policy settings. If the economy is running at full steam then our interest rates will generally be higher, and the reverse is generally true. However, our currency and markets are relatively “free floating”, which means our currency and interest rates are highly influenced by global forces.

As mentioned in an earlier post, when America’s Federal Reserve announced it may stop printing money sooner rather than later, US interest rates outside the control of the Fed immediately started to rise. The Australian Financial Review (“Bond carnage set to rattle investors”, p28 19.8.13) article highlights the $US40.8 billion in Treasuries that were sold off in the latest bout of interest rate jitters. They haven’t stopped rising as yet – even though the Fed has said it will only be slowing down its printing, not stopping it. Australia’s longer term bond yields also started to rise, and that makes sense owing to our open economy and the need to compete against the US interest rate mammoth in the room.

20130819 Bernanke to world we're gonna taper sooner rather than later

When looked at over 20 years, the latest interest rate changes don’t look that big… but a move from ~1.6% to 2.8% in 10 weeks is a large movement…

The point here being that Australia’s interest rates are prone to outside influences almost as much as local inputs, and that will require Australia’s politicians and central bankers to walk a wary line over the coming year or two or risk sending our economy into a bit of a spin.

It also means that care should be taken when looking at strategies that are interest rate dependent over the next few years.

Disclaimer : Remember, nothing in this post or on this site is to be considered personal financial advice. It is commentary and opinion only, and at most could be considered advice of a general nature that cannot be applied to an individual’s personal circumstance. If you want personal advice, that can only be provided by a suitably qualified adviser after due investigation into your personal financial position, objectives and risk profile.




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