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How do interest rates affect your investments?
Interest rates are an important financial lever for world economies. They affect the cost of borrowing and the return on savings, and it makes them an integral part of the return on many investments. It can also affect the value of the currency, which has a further trickle-down effect on other investments.
So, when rates are low they can influence more business investment because it is cheaper to borrow. When rates are high or rising, economic activity slows. As a result, interest rate movements are also a useful tool to control inflation.
Rising steadily
For the past few years, interest rates have been close to zero or even in negative territory in some countries, but that all started to change over the last year or so.
Australia lagged other world economies when it came to increasing rates but since the rises began here last year, the Reserve Bank of Australia (RBA) has introduced hikes on a fairly regular basis. Indeed, the base rate has risen 4 per cent since May last year.
The key reason for the rises is the need to dampen inflation. The RBA has long aimed to keep inflation between the 2 and 3 per cent mark. Clearly, that benchmark has been sharply breached and now the consumer price index is sitting at 6 per cent for the quarter to June 2023.
Winners and losers
There are two sides to rising interest rates. It hurts if you are a borrower, and it is generally welcomed if you are a saver.
But not all consequences of an interest rate rise are equal for investors and sometimes the extent of its impact may be more of a reflection of your approach to investment risk. If you are a conservative investor with cash making up a significant proportion of your portfolio, then rate rises may be welcome. On the other hand, if your portfolio is focussed on growth with most investments in say, shares and property, higher rates may start to erode the total value of your holdings.
Clearly this underlines the argument for diversity across your investments and an understanding of your goals in the short, medium, and long-term.
Shares take a hit
Higher interest rates tend to have a negative impact on share markets. While it may take time for the effect of higher rates to filter through to the economy, the share market often reacts instantly as investors downgrade their outlook for future company growth.
In addition, shares are viewed as a higher risk investment than more conservative fixed interest options. So, if low risk fixed interest investments are delivering better returns, investors may switch to bonds.
But that does not mean stock prices fall across the board. Traditionally, value stocks such as banks, insurance companies and resources have performed better than growth stocks in this environment. Also investors prefer stocks earning money today rather than those with a promise of future earnings.
But there are a lot of jitters in the share market particularly in the wake of the failure of a number of mid-tier US
banks. As a result, the traditional better performers are also struggling.
Fixed interest options
Fixed interest investments include government and semi-government bonds and corporate bonds. If you are invested in long-term bonds, then the outlook is not so rosy because the recent interest rates increases mean your current investments have lost value.
At the moment, fixed interest is experiencing an inverted yield curve, which means long term rates are lower than short term. Such a situation reflects investor uncertainty about potential economic growth and can be a key predictor of recession and deflation. Of course, this is not the only measure to determine the possibility of a recession and many commentators in Australia believe we may avoid this scenario.”
What about housing?
House prices have fallen from their peak in 2022, which is not surprising given the slackening demand as a result of higher mortgage rates.
Australian Bureau of Statistics data showed an annual 35 per cent drop in new investment loans earlier this year.
new investment loans earlier this year.
The changing times in Australia’s economic fortunes can lead to concern about whether you have the right investment mix. If you are unsure about your portfolio, then give us a call to discuss.
- i https://www.ig.com /au/ trading-strategies/ what-are-the-effects-of-interest-rates-on-the-stock- market-220705
- ii https://www.macrobusiness.com.au/2023/02/inverted-yield-curve-predicts-australian- recession/#:~:text-Since%20the%20great%20 bond%20yield,the%20shape%20of%20the%20curve
- iii https://www.abs.gov.au /statistics /economy /finance /lending-indicators /latest-release
Current as at Sep 2023
3 graphs that explain what’s happening with Australian wages
AMP’s Deputy Chief Economist, Diana Mousina explains the slow growth of Australian wages and the impact on inflation.
1. Wages growth slows… but still at 10-year high
Wages increased by 0.8% in the June 2023 quarter, equating to 3.6% year on year which was slightly below expert predictions.
If you include bonuses, the pace of growth slowed to 3.7% year on year, from 3.9% last quarter. On an annual basis, this means wages growth is running at 3.4%, well below the peak of 4.3% in September last year but still around a 10-year high. Before the pandemic, it was around 2% a year. The tight labour market and high inflation have helped to increase wages in recent years.
The main drivers in the June quarter were construction (+1.3%) and professional, scientific and technical services (+0.7%).
2. Real wages growth is improving as inflation slows…but still in negative territory
Once you add inflation into the mix, it’s a very different picture with real wages going backwards. But as inflation slows, the rate of decline is slowing and is now at -2.4% year on year, up from a low of -4.4% in December last year. And we should see further improvement in real wages from here as inflation slows, which is positive for consumer sentiment and household purchasing power.
3. Private sector driving wages growth…but get set for a shift
Wages growth in the private sector was up by 3.8% over the year to June, compared to 3.1% in the public sector. But we’re likely to see a turnaround as increased unemployment affects the private sector more.
What wages growth means for inflation…and rates
Wages should grow more strongly in the September quarter due to the impact from the increased minimum and award wages brought in on 1 July 2023
We see growth peaking at just under 4% later in the year before a slowdown in the labour market takes some heat out. But wages growth could still be higher than expected, depending on the speed of the slowdown and any broader wage gains stemming from the minimum and award wage changes.
While wages aren’t increasing at a pace that would threaten the Reserve Bank’s 2-3% inflation target, they’re still a risk to inflation, particularly as productivity growth remains low.
So, while the June figures allow the Reserve Bank to breathe a sigh of relief and keep rates on hold, any signs that wages growth is reaccelerating would be a cause for concern.
This article has been written by Diana Mousina, Deputy Chief Economist at AMP.
Current as at Sep 2023