Monthly economic e-news – November 2020
13 November 2020
By Craig Turnbull
Chief Investment Officer
Reserve Bank cuts rates despite the recovery being under way
Just before the running of the Melbourne Cup this year, the Reserve Bank of Australia (RBA) announced a package of measures to support job creation and the recovery of the Australian economy from the pandemic.
In the announcement, RBA Governor, Philip Lowe, declared that, "In Australia, the economic recovery is under way and positive GDP growth is expected in the September quarter", but to support the ongoing recovery the RBA cut the official interest rate to a historic low of just 0.1%.
Why has the Reserve Bank introduced these measures?
While the RBA remains optimistic in the short term, the bank expects the longer-term recovery from COVID-19 may be "bumpy and drawn out."
The RBA’s plan to cut interest rates and purchase $100 billion of government bonds is designed to reduce borrowing costs, boost business and government investment, and ultimately create more jobs.
Officially, the seasonally adjusted unemployment rate was 6.9% in September, but this figure is being kept artificially low by the JobKeeper payments. The RBA expects unemployment to remain high as support payments are wound back next year, peaking just below 8% and then falling back to 6% by the end of 2022.
Globally, China has recovered strongly from the initial outbreak of COVID-19, but the recent surge in infections in the US and Europe pose a risk to global growth in the short term until an effective COVID-19 vaccine becomes widely available.
In the meantime, the interest rate cuts should put some downward pressure on the value of the Australian dollar and help stimulate the local economy by making our exports more competitive on international markets.
What are the risks of very low interest rates?
In his statement, the Governor stated that the RBA will not raise the official cash rate until the inflation rate is within the target range of 2% to 3%. Based on this target it’s estimated that the cash rate may not rise for at least three years.
This is great news for existing home loan borrowers, but persistent low rates have the potential to inflate asset values, particularly residential property.
Property prices are already on the rise in all capital cities, except Melbourne, and in many regional areas. According to CoreData, the prices of all dwellings in Sydney are up 6.09% for the year to October, just behind Canberra (6.76%) and Hobart (6.45%).
The risk is that low interest rates may inflate a property bubble, increasing household debt and making homes more unaffordable in key regions of the country.
The rate cuts will also further reduce returns from term deposits and cash investments, tempting retail investors and self-funded retirees to take on more risk and wade into the share market.
However, if the economic recovery proves to be “bumpy and drawn out”, the share market may remain volatile and unpredictable with some sectors of the economy taking much longer to return to pre-pandemic levels.
What does this mean for super and investment returns?
The aim of the RBA package is to boost economic growth and is likely to be positive for super and investment returns over the short to medium term.
However, self-funded retirees facing the prospect of diminishing returns from their cash investments may need to explore different strategies to better fund their retirement.
Good financial planning advice can help you understand your options and maximise your retirement income in the current environment.
Take a look at the latest LGS performance results.
Markets at a glance
for the month ending 31 October 2020
Australian shares1 up by 1.93% (ASX 200 Accumulation Index)
10 year Australian Government Bonds yield2 down to 0.775%
Australian dollar down to US$0.7044
RBA Cash rate3 steady to 0.25%*
International shares4 down by 3.20% (MSCI – World ex Australia (USD)
*RBA reduced the official cash rate to 0.10% on 4 November 2020