The implications of lower interest rates

The implications of lower interest rates

As was widely anticipated, the RBA lowered interest rates at its December meeting this afternoon by 25 basis points. The official cash rate now sits at 3.00%, which was also the emergency low we saw in the immediate aftermath of the Global Financial Crisis. In a fairly measured statement, the RBA cited enduring uncertainties in Europe and the US, a moderation in demand out of China, and some recent weakness in local data as justification for easing. Growth is around trend, and inflation is on target at 2.5%.

Despite lower rates serving as a sobering reminder that our economy isn’t immune from the woes emanating from the northern hemisphere, rate cuts are typically met with popular fanfare from the public and share market alike, due to the relief they offer household borrowers and the bullish implications for equities.

However, there are also negative consequences of lower rates, which affect those investors who rely on income from instruments such as term deposits, high grade bonds and money market funds. When evaluating the income (net of tax and inflation) being offered by a lot of these instruments at current levels, their return is close to zero. Should economic conditions in 2013 deteriorate further, both locally or abroad, it’s entirely possible that we could see rates lower still (as some pundits are already forecasting), in which case the real income offered by these investments, net of tax, could easily be negative!

In this context, it’s no surprise how well the high-yield segment of the market has been faring recently, and we see this trend gaining more momentum into next year. As such, we feel compelled to remind everyone of the continued strong performances of both our Income Portfolio, which is yielding 8.5%, and our Blue-Chip Portfolios, which are averaging a return of 12%, with risk that we consider to be very acceptable.

Both strategies offer an attractive income stream through dividends or coupon payments, with the added benefit of capital growth should the price of any constituent securities increase in value. The Income Portfolio has a more conservative risk profile compared to the Blue-Chips, with limited opportunity for capital appreciation, and therefore a lower expected return. Nevertheless, in this environment of record low interest-rates, with the prospect of further lows, and given their risk-profiles, both strategies deserve serious consideration.

If you’d like more information on our Income and Blue-Chip portfolios, please don’t hesitate to contact us on 1300 748 546.

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