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Dispelling The Super Interest Rate Myth

There’s a spurious argument doing the rounds that low interest rates hurt retirees. It is based some notion that it is a bad thing that the fall in deposit interest rates to around 4 to 4.5 per cent in the wake of the easing in monetary policy from the Reserve Bank lowers investment returns for savers.

This argument is scandalously wrong and seems to be a perpetuation of the snake oil from those wanting to peddle gloom and create erroneous perceptions of broadly-based economic hardship.

It pains me to spell out some very basic economics that I have spoken to year 12 economics students about this year, but here is why easy monetary policy based on low inflation and solid productivity gains is good news for investors.

Easier monetary policy in the form of lower interest rates from the Reserve Bank will boost economic activity. With a stronger economy comes higher company profits, share prices and dividends. This means that for someone with a balanced investment portfolio where there is an allocation to each asset class of cash, shares, property and fixed income, there will be strong returns from their share, bond and property portfolios in a low interest rate environment while interest income growth slows.

Very basic portfolio theory suggests that sort of split will cover an investor for times when interest rates are cut (lowering the interest rate return) because this will boost returns in the share and property components of the portfolio. Just as it is wrong to focus on the one company whose share price has plummeted in a portfolio of 20 stocks, it is wrong to say that low interest rates alone are damaging investors’ income returns. It is especially silly when the returns on deposits are still positive and above the rate of inflation, which is the case now.

At some stage in the next few years, there will be a monetary policy tightening cycle and the deposit interest rates will rise. Interest returns will clearly be higher, but this will likely be at the expense of softer returns for shares, bonds and property.

This is not rocket science.

Low interest rates are great news for superannuates with a balanced portfolio. The benefits of easy monetary policy will inevitably swamp any scaling back in interest income from savers given the positive effect on the economy.

In terms of the Reserve Bank’s overall policy objectives, monetary policy is designed to entrench inflation in the 2 to 3 per cent target band rather than have it fall to something below 2 per cent, which means that economic growth is likely to be around a healthy 3 per cent pace, rather than have it falter towards 2 per cent or less. With decent growth and low inflation, there will be decent job creation and the unemployment rate will be anchored near 5 per cent (plus or minus a few tenths).

Companies hanker for these sorts of domestic macroeconomic dynamics and they are being delivered on a platter with the current policy mix.

Ongoing resilience in the economy is also a critical factor underpinning government finances. As has been all too evident for decades, the government gains windfall revenue and structurally spends less when the economy is strong, and suffers a revenue shortfall and has higher claims on spending when the economy is weak.

This is why low interest rates and their supportive effect on the economy help boost public finances which is turns allows the government to be a service provider for the whole community, including those with interest income. One reason for the extremely generous level of pensions and tax treatment of superannuation funds is the fantastic position of public finances.

One only has to look to Europe to see the austerity measures imposed on pensioners, pension policy, and a whole range of other services to see the problems when public finances are unsustainable. Australia is a million miles from that scenario.

There are a number of other issues to consider before falling for the crocodile tears that flow from low interest rates.

Since October 2011, just before the Reserve Bank’s interest rate cutting cycle started, the ASX total return has been a chunky 22 per cent, more than enough for any reasonable investor in a little over 12 months. Recall that inflation has risen by around 2 per cent over that time.

The bottom line is that different asset classes perform differently at different stages of the economic cycle. This should be obvious. For anyone to focus on the cyclically weakest part of any portfolio while ignoring all others is misleading and mischievous at best. The low interest rate environment is good news for the economy, job seekers, the government’s finances and investors. Enjoy it while it lasts.

Source: Business Spectator online newsletter- published by Australian Independent Business Media (AIBM) Pty Ltd

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