Why Australian investors are impacted by international interest rates
Overseas economic events may impact your investments
In 2017’s global economy it’s impossible for any country to behave as though it’s in a vacuum. These days, every developed country is interconnected and even if Australian shares no border with another nation, economic factors like international share prices and interest rates affect Australian investors. Australia is an importer and exporter of goods and services, a tourism destination and a buyer and seller of cash and financial products. This means interest rate changes in other countries impact on the Australian economy, and ultimately your investments. It pays to be aware of this influence because it may help to inform your investment decisions in the lead up to, and during, your retirement.
Interest rates are the price of money. If you need to borrow money, the interest rate is how much the bank is happy to lend you money at, given the return they require to make the transaction commercial for them. If you’re borrowing in Australia this rate will include a margin over the ‘cash rate’ set by the RBA. The cash rate is also the basis for the interest rate a bank is willing to pay you on your deposits.
Interest rates are one indicator of the health of a country’s economy. For example, when the USA raises its cash rate, it’s signalling that the US economy is strengthening. This encourages big investors to choose the USA over countries with lower interest rates.
“By raising interest rates the US Fed Reserve encourages big investors to choose the USA over countries with lower interest rates.”
Global interest rates have a wide (and unpredictable) sphere of influence
For superannuants and investors, international interest rates will most likely affect the rate you’re paying on investment loans or margin loans for shares and how much interest you receive on your cash balances or term deposits.
The country with the most global influence on interest rates is of course, the USA, and its Federal Reserve Bank (known as the Fed or the Fed Reserve). Once upon a time, when the Fed raised or lowered the American cash rate, Australia’s Reserve bank would follow suit and the Australian banks would then follow on. However, this has not been the case since the mid 1990s. Saul Eslake, a well-known Economist and Vice Chancellor’s fellow at the University of Tasmania says this is because Australia’s economic cycle does not follow the US cycle as closely as it used to. Australia’s trade relationships with the USA have also changed since the 1990s1.
So, international interest rates do affect Australia but not always directly, immediately or proportionately.
For instance, during the GFC the Australian Reserve Bank held off on reducing interest rates because the Australian economy managed to withstand the impact of the crisis for several months. Although the RBA did eventually reduce rates, and investors suffered with a 10% reduction in share values, the economy as a whole stayed stronger than those of many other developed countries2.
Interest rates and investment loans
When an overseas national Reserve Bank like the Fed raises US interest rates, the impact on Australian rates isn’t immediate but it’s still telling. Most Australian banks borrow money from US banks to fund their activities. If the cost of their borrowing increases because the Fed rate has gone up, it will eventually impact customers borrowing from them3. Even if the RBA hasn’t raised interest rates in response to the Fed move, the Australian banks may still raise rates independently, to offset the higher rates in the US biting into their profits. Australian banks have proven many times that they will not always follow the RBA’s lead with interest rates.
Interest rates and cash deposits
For investors with cash deposits, a rise in interest rates is a good thing. In July 2017, any investor with a decent sized cash balance would be lamenting the low returns available. As your retirement date nears, increasing your cash holdings as a proportion of your investments is traditionally considered a wise move because of the reduction in risk. This means many Australians who are nearing their retirement date are moving into a cashed-up situation that doesn’t offer them much reward in terms of interest income.
Chances are that as the Fed Reserve continues to raise US interest rates Australia will eventually follow with an interest rate rise of its own to keep Australia attractive as an investment opportunity. But the question is when? The RBA Governor’s report on the July 2017 rate decision was not predicting a rise for some time4. Until then, any cash reserves you’re holding as an investor, will not net you high returns. What you do about this is up to you, but we suggest a conversation with your financial adviser might be in order.
Interest rates on the rise overseas can still impact Australian investors. Source: Adobe Stock
Interest rates and the share market
Rising interest rates mean cash investments become more attractive which is not great news for share markets. In times of lower interest rates, share markets are popular with investors who are happy to take on a little more risk for the chance of a better return than cash4. Money is cheaper, so investors can borrow more to purchase shares. Once interest rates rise, investors might be discouraged from borrowing (or borrow less). They may also begin to find cash deposits more enticing.
The Federal Reserve has raised the USA cash rate three times since November 2016. It’s now between 1% and 1.25%. It’s hard to tell if or when the RBA will follow and increase Australia’s cash rate, which have remained on hold at a very low 1.50% since August 20165. Late 2017, early 2018 will be interesting times.
Do you like to keep an eye on overseas interest rates? Or do you prefer a more local focus? For more information and guidance on how your investments may (or may not) be affected by international interest rates contact our experts at Modoras. Call 1300 888 803 or book an appointment here.
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