The economy is affected in various ways by interest rates, such as loan prices, housing, and purchasing. Changes to these rates occur in the United States and Australia, leading to discussions around how they will affect both countries in the following months.

Interest Rate Cuts: Tracking the Pros and Cons

The 25-basis-point cut in Australia is the first in many years, creating discussion around its effects. Mortgage holders with variable loans will benefit, but now there is worry that the reduction is too large. For the portion of Australians with a mortgage, the rate cut helps them afford to spend more money and pay their debt off quicker. The majority of Australian citizens without a mortgage will not reap the benefits of the cut.

On the contrary, retirees who depend on bank deposits to pay them interest will begin losing money. When rate cuts are implemented, banks make it extremely difficult for depositors to withdraw their funds while savers don’t get any benefit. If your provider hasn’t sent the interest rate cut yet, it is probably time to start looking for a new service.

The US and Australia: Different Approaches Together

While Australia and the US are working together to bring down inflation, their strategies remain distinct. The US Federal Reserve has begun cutting rates, with a total reduction of 75 basis points. In my opinion, there won’t be any more cuts in the first half of this year because we still have to look out for inflation. Unlike Australia, the Fed’s monetary policy is much more reactive in regards to the economic state of the US. There is very strong communication from the Fed that lowers uncertainty in the markets, fostering what’s known as a ‘soft landing.’

The Australian economy, however, is unlike that of the US in terms of how quickly they raised interest rates in correlation with inflation. Additionally, the Australian dollar has depreciated in comparison to the US dollar, making imported goods like fuel more expensive. This can result in what is known as ‘imported inflation’ which can nullify the benefits that the rate cut achieved.

Effect on Investment Choices

For a country’s economy to thrive, policy makers need to be cautious about how interest rates affect investment decisions. With constantly changing rates, borrowing tends to get more expensive and eventually slows down the value of real estate as well as the stock market. On the other hand, once the rates dip, investors become more willing to put their money into stocks and property.

• Stocks: Financial institutions could face reduced profits, as over-leveraged firms may benefit from lower borrowing costs. In a low-rate environment, high-dividend paying stocks are likelier to become attractive.
• Bonds: Existing bondholders benefit from lower rates, which tend to increase bond prices. However, newer bond investments come with lower yields.
• Real Estate: Interest rate cuts are expected to somewhat ease mortgage servicing costs in theory, but the Australian housing market structurally is supply-side driven. This could push property values even higher and would make attaining home ownership more difficult for first-time buyers.

What to Expect Next

The Reserve Bank of Australia (RBA) is expected to err on the side of caution with any further rate cuts. A slowing Australian economy due to weak consumer spending, coupled with external risks from China’s economy, means the RBA will want to gauge the effects of this cut before moving again. The upcoming election could also affect policy moves, as the government is likely to boost spending ahead of the vote.

In the US, inflation is one of the big worries for policymakers. The monthly FPPI and consumer price index data will heavily influence the next decision made by the Federal Reserve. If things continue along the same vein, the Fed is likely to keep rates unchanged.

Final Thoughts

While the short-term relief for borrowers is appreciated, the debt spiral could draw in savers with their weaker returns, inflation potentially building up and various other trade-offs. Trying to predict where the market is headed can be tedious, especially for investors looking to minimize their risk. It is paramount that everyone is vigilant and willing to adapt economically in order to make important financially driven decisions such as investing in stocks or property.