How low can rates go?

For reasons best known to themselves, the RBA appear to be cutting rates bit by bit.
For reasons best known to themselves, the RBA appear to be cutting rates bit by bit.

The Reserve Bank has spoken, and interest rates have been slashed by another 0.25 per cent - to 1 per cent, the lowest in Australia's history. The logic is beyond me.

Once again, I was one of 40 "experts" who were asked to forecast what the bank would do last Tuesday. Twenty-seven forecast the cut: I was one of the minority who predicted no change. Economics is not my strongest suit, but I do know that interest rate changes take more than four weeks to do whatever they are supposed to do, and to me it was a no-brainer that a prudent Reserve Bank board would give their last changes time to work before cutting again.

Let's face it, if the bank thought four weeks ago that the situation was dire, they could have gone the whole hog then, and made a major public statement by announcing a full 50 basis points. Instead, for reasons best known to themselves, they appear to be cutting rates bit by bit.

The bank claims the economy needs stimulation, yet the message on the evening news last Tuesday was "the bank is trying to rejuvenate a weakening economy, and protect us from a meltdown in Europe". I doubt that news will send viewers on a spending spree.

Do we need another rate cut? It's just seven weeks since the federal election, and every business person I speak to tells me there has been a resurgence of enquiries and business confidence. They also point out that the cost of money is the least of their worries - much bigger items are salary on-costs and power bills.

I have lost all faith in my forecasting ability, but one certainty is that we are in uncharted waters. The monthly survey also asked us to predict how far rates will drop. A massive 72 per cent of the respondents forecast that rates would bottom at 0.75 per cent but a third of them are expecting the Reserve Bank to keep slashing rates until they bottom at 0.50 per cent.

But the big question is - where is the world going? German 10-year bonds are now yielding just -0.32 per cent, which is close to a record low, and there are strong indications that both the American and European central banks will cut rates further. Austria are issuing hundred-year government bonds at 1.2 per cent! You may well ask why anybody would invest in a hundred-year security at such low rates - the answer is that they think rates will drop lower, in which case the value of a 1.2 per cent bond will rise.

Just last week the Wall Street Journal ran an article about a couple living in Denmark who have a loan of the equivalent of AUD$300,000 and who now have negative loan repayments. This is not a misprint: every month the bank pays them 249 Danish kroner. Their current mortgage rate is -0.0562 per cent. It's no wonder property is booming in Denmark if you get paid to take a mortgage out.

Could we ever have negative mortgage rates in Australia? I have no idea, but what I do know is that the world appears to be in a downward interest rate cycle. This means income-producing assets like property and shares will be in more demand than ever as rental income and franked dividends look far more attractive than minuscule returns from bank deposits.

Falling rates should also mean our dollar will weaken against the American dollar, which is good news for exporters, and for investments in international managed funds.

If you have a loan, grab the opportunity to get way ahead of your repayments. The economic cycle is not dead - at some stage rates will rise again. The big question is when.

  • Noel Whittaker is an Australian expert on personal finance and the author of Making Money Made Simple. Send your money questions to noel@noelwhittaker.com.au.