The Reserve Bank of Australia (RBA) announced another rate rise on the 2nd August, after hikes in May, June and July.
We unpack what interest rate rises mean for you and your super…
At its August meeting, the RBA decided to further lift the cash rate by half a percentage point to 1.85%. This is the fourth rate increase since May after 11 years of rate cuts.
Rate increases are a reflection of economic conditions. Central banks raise and lower interest rates to stimulate economic growth and manage inflation. If inflation is high, they might raise rates to try to control it. If it’s low, they may lower rates to encourage consumers to spend and borrow money.
Throughout the COVID-19 era, very low interest rates have supported economies around the world. And the combined effect of low interest rates and government hardship payments proved very effective in stabilising the Australian economy.
Yet lately, supportive government spending and monetary measures have coincided with supply side shocks such as Russia’s invasion of Ukraine, lockdowns in China and COVID-19 related labour shortages. These have resulted in excess demand which can not be met by supply and higher inflation.
At some point, central banks, including the RBA, needed to raise interest rates back to normal levels, but these shocks are pushing up rates faster than expected.
In recent years, low interest rates bolstered share and fixed interest markets. Now, these markets are adjusting to higher long-term interest rates.
Compared to long-term averages, the official cash rate is still very low. And although we expect rates will continue rising for the next 12 months, we don’t expect rates to climb to the levels seen in the 1990s or immediately following the global financial crisis in 2008.
How will rate rises affect me?
Investors
Interest rate rises are impacting all types of investments to varying degrees:
- Shares. While share markets tend to react to political and economic news, like interest rate movements, any volatility is usually short-lived. As long as the economy remains strong and companies can grow their earnings, shares have historically performed reasonable well during periods of rising interest rates.
- Property. Direct property and property securities are impacted by rising interest rates because higher rates tend to reduce the borrowing capacity of borrowers. Higher interest rates can also slow down the property market by reducing demand.
- Cash and fixed interest. Fixed interest investments, like bonds, are also impacted because the prices of existing bonds that are paying a fixed interest rate fall. This can cause negative returns for fixed interest investments over the short term.
Super members and retirees
If your super is invested across several asset classes – like Australian shares, global shares, property, fixed interest and cash – an interest rate rise could make your super balance go up or down, depending on how it’s invested. This might be a good time to review your investment strategy to make sure your portfolio is well-diversified and appropriate for your stage of life.
For retirees, higher interest rates can be a good thing. As people near retirement, they often change their investment strategy, so they have a higher allocation to defensive assets (such as fixed interest and cash) and a lower allocation to growth assets (such as shares and property). People closer to retirement tend to have a shorter-term investment time horizon and more money to invest. And having a lower allocation to high-risk assets means they’re likely to experience less volatility overall.
People who have retired may also have more money invested in bank deposits and other low risk investments. Now that interest rates are higher retirees may be appreciative that they will receive higher interest on their bank deposits.
Borrowers
There has been plenty of speculation about the impact of interest rate rises on borrowers.
In January, average households were almost four years (45 months) ahead of principal and interest mortgage payments and 52 months ahead of interest-only mortgage repayments, according to figures from the Australian Prudential Regulation Authority (APRA).
Many Australians have also been saving throughout the pandemic. Data from the Australian Bureau of Statistics shows the household savings ratio has increased from 3.6% in the December quarter of 2019 to 13.6% in the December quarter of 2021². But it’s important to note that with higher inflation, the real value of savings is reduced.
How will a rate rise impact my super?
We’ve seen negative returns in 2022 across most investment options. This is because share markets tend to react to changes in interest rates.
Investments in property can be impacted by rising interest rates because they tend to reduce the borrowing capacity for investors and borrowers. Higher interest rates can also slow down the property market by reducing demand.
Fixed interest investments, like bonds, may also be impacted by long-term interest rate rises. In this circumstance, the price of bonds will typically fall.
It’s important to take a long-term view when looking at your super. Longer-term returns on CFS’s investment options are positive.
Any volatility is usually short-lived. History shows that people who stick with their strategy and remain invested are generally rewarded.
If you make regular contributions to your super, you’re now investing in markets that are lower priced than they were a year ago.
¹Source: APRA figures provided exclusively to The Australian (News Ltd) on 9 January. Published here.
²Source: Australian National Accounts: National Income, Expenditure and Product (ABS data); December 2019 and December 2021
Source Article: Colonial First State – 2nd August 2022
